UNIVERSITY  OF  CALIFORNIA 
AT  LOS  ANGELES 


INVESTMENT  ANALYSIS 


THE    MACMILLAN    COMPANY 

NEW  YORK    •    BOSTON    •    CHICAGO    •    DALLAS 
ATLANTA   •    SAN  FRANCISCO 

MACMILLAN  &  CO..  LIMITED 

LONDON    •    BOMBAY    •    CALCUTTA 
MELBOURNE 

THE  MACMILLAN  CO.  OF  CANADA.  LTD. 

TORONTO 


Investment  Analysis 


FUNDAMENTALS   IN   THE   ANALYSIS  OF 
INVESTMENT  SECURITIES 


BY 

WALTER  EDWARDS  LAGERQUIST 

PROFESSOR  OF  FINANCE  IN  NORTHWESTERN  UNIVERSITY 


gorfc 
THE  MACMILLAN  COMPANY 

1927 

All  rights  reserved 


COPYRIGHT,   1921, 
BT  THE  MACMILLAN  COMPANY 


Set     up    and    electrotyped. 
Published    September,   1921. 
Reprinted  January,  August 
1922;  January,  1924:     July, 
1627. 


Printed  in  the  United  States  of  America  by 

THE    FEBBIS     PRINTING     COMPANY,    NEW    TORE 


KG 


Si     (,  TO  MY  FRIEND  AND  FORMER  TEACHER. 


IRVING  FISHER 


I 


PREFACE 

Numerous  difficulties  lie  before  the  writer  of  a  book  on  any 
business  subject.  Particularly  is  this  true  in  the  field  of 
investments,  where  many  mooted  points  exist,  and  lack  of 
standardization  in  many  security  issues  still  prevails.  Every 
investment  is  an  individual  problem.  Consequently  to  apply 
a  standard  form  of  analysis,  and  at  the  same  time  allow  suffi- 
cient elasticity  in  treatment  for  the  qualifications  which  must 
be  constantly  made  in  practice,  places  a  large  task  upon  the 
author.  There  is  also  no  business  subject  in  which  one  is  forced 
to  deal  with  the  technical  aspects  of  so  many  subjects.  Some 
will  doubtless  criticize  the  present  text,  because  of  its  large 
inclusions  from  the  fields  of  corporation  finance,  accounting, 
law,  banking,  and  engineering.  Though  every  author  would 
draw  from  all  of  these  fields  in  varying  degree,  no  author 
undertaking  a  complete  analysis  of  investment  securities  would 
eliminate  any  one  of  them. 

With  so  many  complexities  involved,  the  author  may  con- 
ceive his  task  too  ambitiously  and  unconsciously  sacrifice  clear- 
ness and  simplicity  of  plan  which  are  so  essential  in  the 
exposition  of  a  large  subject.  In  the  attempt  to  be  thorough 
and  scientific,  the  author's  treatment  of  the  subject  may  be  so 
complex  that  the  expert  alone  can  follow  it.  On  the  other 
hand,  the  author  may  be  misled  into  a  superficial  treatment 
and  fail  to  establish  a  foundation  upon  which  the  student  may 
build  in  the  future.  Whether  this  book  has  succeeded  in 
evading  these  dangers  or  not,  the  author  has  prepared  it  with 
the  full  realization  of  these  difficulties. 

An  effort  has  been  made  to  state  the  fundamentals  of 
analysis  of  investment  securities  in  such  form  that  they  will  be 
understandable  to  an  intelligent  person  who  has  not  made  a 
systematic  study  of  investments.  While  the  book  has  been 
written  for  beginners,  no"attempt  has  been  made  to  avoid  close 

vii 


viii  PREFACE 

and  difficult  analysis,  where  it  has  been  essential  to  make  a 
complete  presentation  of  a  particular  subject.  Neither  is  it 
possible  to  make  all  things,  in  such  a  complicated  subject,  of 
"primer-simplicity" — and  the  author  makes  no  such  claim 
Any  one  who  avoids  close  reasoning  in  the  study  of  investments 
can  never  hope  to  have  anything  but  a  superficial  knowledge 
of  the  subject — and  this  is  too  frequently  an  erroneous 
understanding. 

While  most  of  the  material  in  this  book  has  been  gained 
from  practical  experience  and  investigations  in  bond  and  bank- 
ing houses,  the  method  of  exposition  has  developed  out  of  sev- 
eral years  of  experience  in  teaching  the  subject-matter  to  both 
college  students  and  business  men.  The  method  which  experi- 
ence has  shown  to  be  the  best  adapted  to  these  men,  has  seemed 
to  the  author  to  be  the  logical  method  of  presentation.  Books 
Two,  Three  and  Four  of  the  volume,  assume  an  understanding 
of  the  material  covered  in  Book  One.  To  avoid  constant  repe- 
tition, this  has  been  necessary,  so  that  the  reader  should  not 
draw  the  conclusion  that  some  important  general  principle  or 
condition  has  been  omitted  if  he  first  reads  chapters  subsequent 
to  Book  One.  While  there  are  many  miscellaneous  facts,  which 
it  is  hoped  will  be  found  useful  and  can  be  found  through 
reference  to  the  Table  of  Contents  and  the  Index,  the  various 
parts  of  the  book  have  been  closely  interwoven.  For  convenient 
reference  of  facts  a  very  complete  index  has  been  made,  and  for 
the  same  purpose  the  various  kinds  of  bonds  have  been  alpha- 
betically catalogued  in  the  Appendix.  No  pretense  has  been 
made  to  make  the  bibliography  exhaustive,  though  the  claim 
can  be  made  that  it  is  representative  in  all  respects. 

Because  of  the  meagre  amount  of  material  available  on 
some  securities,  the  chapters  cannot  be  evenly  balanced  either 
in  scope  or  character  of  treatment.  Some  topics,  especially  in 
closely  allied  fields,  have  already  been  so  fully  covered  that  a 
brief  treatment  has  seemed  quite  sufficient.  Lack  of  uniformity 
and  standardization  in  other  issues,  make  other  than  general 
conclusions  impractical.  While  the  author  has  been  fully  con- 
scious of  the  exceptions,  which  must  constantly  be  made  in  any 
attempt  at  standardization  in  the  analysis  of  industrial  securi- 


PREFACE  fc 

ties,  an  attempt  has  been  made  to  treat  the  more  basic  rules  of 
analysis  applying  to  these  securities. 

Though  a  discussion  of  telegraph,  telephone  and  electric 
light  company  bonds  also  has  been  ventured,  an  analysis  of 
these  is  rather  difficult,  as  they  have  just  passed  through  their 
initial  development,  added  to  which  they  possess  in  common 
with  industrial  securites,  a  lack  of  uniformity.  In  railroad 
finance,  uniform  standardization  has  long  been  well  established. 
The  constitutional  and  statutory  regulations  which  control  the 
issuance  of  civil  obligation  have  established  a  fairly  close  uni- 
formity thus  making  classification  and  analysis  possible.  There 
is,  however,  much  still  to  be  done  in  this  field.  It  is  surprising 
that  with  the  wealth  of  material  which  has  so  long  been  avail- 
able in  the  Commercial  and  Financial  Chronicle  that  so  little 
real  original  and  constructive  work  has  been  done  in  the  subject 
of  municipal  finance.  Of  such  securities  as  irrigation,  timber, 
etc.,  bonds,  a  briefer  treatment  might  seem  warranted  than 
that  given  here.  However,  their  unfortunate  early  experiences 
and  the  lessons  a  study  of  them  contributes,  would  seem  to 
justify  the  space  given  to  their  discussion.  The  discussion  of 
steamship  bonds  is  confined  to  the  Great  Lake  Steamship  bonds. 
While  there  are  particular  ocean  steamship  bonds  which  belong 
in  the  investment  group,  the  lack  of  uniformity  in  these  issues, 
does  not  seem  to  yet  justify  their  inclusion. 

Stocks,  as  such,  have  not  been  specifically  treated.  To  have 
done  so  would  have  necessitated  a  considerable  enlargement  of 
the  volume  which  is  already  large.  As  for  the  evaluation  of 
corporation  stocks,  the  author  believes  that  the  discussions  in 
this  volume  apply  equally  to  stocks  and  bonds,  though  such 
particular  things  as  preferred  stock  regulations  are  not  con- 
sidered. But  here  again,  the  value  of  those  regulations  to  the 
investor  is  wholly  dependent  upon  the  financial  strength  of  the 
corporation.  Other  suggestions,  as  to  method  of  treatment,  or 
inclusion,  or  exclusion  of  other  securities  do  not  seem  to  demand 
further  discussion. 

Whatever  may  be  contributed  in  this  book  in  the  furtherance 
of  an  understanding  of  the  reader  in  the  field  of  investments, 
can  in  a  very  small  measure  be  credited  to  the  author.  There 


x  PREFACE 

are  many  persons  both  in  the  "give  and  take"  of  office  contact 
and  in  seemingly  endless  conferences  who  are  contributors  to 
this  volume.  To  all  these  people  it  is  not  possible  to  give  public 
acknowledgment. 

To  those  who  have  read  parts  of  the  manuscript  and  offered 
valuable  suggestions,  I  desire  to  express  my  indebtedness, 
though  space  does  not  permit  a  detailed  explanation  of  their 
readings,  as  the  list  itself  is  long.  Though  the  author  is  respon- 
sible for  the  decision  upon  all  disputed  points  and  errors,  he 
has  attempted  to  secure  the  advice  and  suggestions  of  experts 
upon  every  kind  of  security.  Particular  acknowledgments  are 
made  to:  Mr.  H.  W.  Addinsell  of  Harris,  Forbes  &  Co.,  New 
York  City;  Mr.  Arthur  Andersen  of  Andersen  &  Co.,  Chicago, 
and  head  of  the  Accounting  Department  of  Northwestern  Uni- 
versity; Mr.  H.  S.  Allen  of  Spencer,  Trask  &  Co.,  New  York 
City;  Mr.  John  Bauer  of  the  Corporation  Counsel  Office  of 
New  York  City,  and  Consulting  Tax  and  Public  Utility  Expert ; 
Professor  Alfred  Bays  of  Northwestern  University  School  of 
Commerce  and  Practicing  Attorney ;  Mr.  H.  H.  Beebe  of  Harris, 
Forbes  &  Co.,  New  York  City;  Mr.  Earnest  D.  Brooks,  Asst. 
Manager  of  Sales  of  Continental  and  Commercial  Trust  and 
Savings  Bank,  Bond  Department,  Chicago ;  Mr.  Clinton  Collver 
of  Lyman  D.  Smith  &  Co.,  New  York  City ;  Mr.  C.  F.  Childs  of 
C.  F.  Childs  &  Co.,  Chicago ;  Mr.  William  R.  Compton  of  Wil- 
liam R.  Compton  and  Company,  St.  Louis;  Professor  George 
Bion  Denton  of  Northwestern  University ;  Mr.  Louis  B.  Fergu- 
son, Manager  of  Sales,  Bond  Department  of  the  Continental 
and  Commercial  Trust  &  Savings  Bank,  Chicago;  Mr.  J.  E. 
Ferris  of  Ferris  &  Hardgrove,  Spokane,  Washington ;  Professor 
Stephen  Gillman  of  Wisconsin  University ;  Mr.  George  A.  Hurd, 
President  of  the  Mortgage  Bond  Company,  New  York  City; 
Professor  E.  W.  Kemmerer  of  Princeton  University;  Professor 
Elmer  Martin  Leesman  of  Northwestern  University  Law  School 
and  Practicing  Attorney ;  Mr.  F.  J.  Lisman  of  F.  J.  Lisman  and 
Company,  New  York  City;  Mr.  Robert  Mallory  of  Spencer 
Trask  and  Company,  New  York  City;  Mr.  Lester  H.  Monks  of 
W.  A.  Harriman  and  Company,  New  York  City;  Professor 
E.  J.  Moulton  of  Northwestern  University;  Mr.  Roy  C.  Osgood. 


PREFACE  xi 

Vice  President  of  First  Trust  and  Savings  Bank,  Chicago; 
Mr.  Julius  Parmelee,  Director  of  the  Railways  Economic 
Bureau,  Washington,  D.  C. ;  Mr.  F.  E.  Payne,  Vice-President  of 
the  Union  Trust  Company  of  Spokane,  Washington ;  Mr.  George 
W.  Pearson,  Manager  of  Bond  Department,  Continental  and 
Commercial  Trust  &  Savings  Bank,  Chicago;  Professor  Guy 
Meredith  Pelton  of  Northwestern  University;  Mr.  Kingman 
Nott  Robbins,  Treasurer  and  Vice-President  of  Associated 
Mortgage  Company,  Rochester,  New  York;  Mr.  Shepard  Smith, 
Vice-President  of  Mississippi  Valley  Trust  Company,  St.  Louis ; 
Professor  John  Charles  Teevan  of  Northwestern  University  an:! 
Practicing  Attorney,  Chicago ;  Mr.  Lewis  K.  Walker,  Vice-Presi- 
dent of  Security  Trust  Company,  Detroit;  Mr.  C.  C.  Wells  of 
Northwestern  University  and  the  Bond  Department  of  Conti- 
nental and  Commercial  Trust  and  Savings  Bank,  Chicago. 

I  particularly  wish  to  express  my  thanks  to  Professors 
Homer  Bews  Vanderblue  and  Walter  Kay  Smart  who  read  the 
whole  of  the  manuscript  in  its  initial  writing  and  to  Mr.  E.  W. 
Bulkley,  senior  member  of  Spencer  Trask  and  Company  of  New 
York,  Chicago,  and  Boston.  Not  only  is  the  author  indebted  to 
Mr.  Bulkley  for  assistance  in  this  work,  but  for  the  opportunity 
and  aid  rendered  him  in  acquiring  his  initial  practical  experi- 
ence in  investment  banking. 


TABLE  OF  CONTENTS 

PREFACE p.  vii 

BOOK  I 

GENERAL  FUNDAMENTALS  AND  THEIR  APPLICATION 
IN  THE  ANALYSIS  OF  INVESTMENT  SECURITIES 

CHAPTER  PAGE 

I.    INTRODUCTION — THE  MEANING  OF  INVESTMENTS.       3 
The   General   Problem— What  the  Field   of 
Investments  Includes — The  Scope  and  Limi- 
tations of  This  Study. 

II.    GENERAL  PRINCIPLES  OF  INVESTMENTS 12 

Safety  of  Principal  and  Income — Rates  of  In- 
come— Marketability — Legality — Stability  of 
Market  Price — Appreciation — Diversification 
— Other  Criteria  of  Investments. 

III.  WHAT  is  INCLUDED  UNDER  INVESTMENT  SECURI- 

TIES, AND  THE  CLASSIFICATION  OF  INVEST- 
MENT SECURITIES  32 

General  Statement — Classification  of  Bonds 
— Character  of  Corporation  Issuing  Bonds — 
According  to  Purpose — According  to  the 
Character  of  the  Lien — According  to  Methods 
of  Payment  and  Redemption. 

IV.  ANALYSIS  OF  THE  CORPORATION  REPORT 51 

Management,  Control,  and  Organization — 
Amount,  Form,  Priority,  and  Margin  of  Secu- 
rities, as  Related  to  Property  Values — The 
Balance  Sheet  and  Valuation  of  Assets. 

V.  ANALYSIS  OF  THE   CORPORATION   REPORT    (Con- 

tinued)          77 

Gross  Sales^— Gross  Revenue — Gross  Earnings 

xiii 


xiv  TABLE  OF  CONTENTS 

CHAPTER  PAGE 

— Operating  Net  Income — Other  Income — 
Fixed  Charges — Dividend  and  Surplus  Poli- 
cies— Statistical  Units  of  Measurements  Used 
in  Analysis. 

VI.    NEGOTIATION  AND  ISSUANCE 95 

Authorization  of  the  Issue — The  Investiga- 
tion— Distribution  of  Corporate  Securities — 
Distribution  of  Civil  Loans — New  York  Stock 
Exchange  Eules  for  Listing. 

VII.    THE  CORPORATION  MORTGAGE 100 

Limitations  of  Issue — General  Provisions  in 
the  Corporate  Mortgage  Instrument — Other 
Creditors'  Claims — Powers,  Eights,  and  Lia- 
bilities of  the  Trustee — Rights,  Powers,  and 
Limitations  in  Foreclosure — Reorganization 
Agreements  and  Procedure  in  Relation  to  the 
Mortgage. 

VIII.  REGISTRATION,  TRANSFER,  AND  ASSIGNMENT  OF 
SECURITIES,  AND  THEIR  VALIDITY  AND  LE- 
GALITY   131 

Section  I.  Transfer  of  Stock — Classification 
of  Transfer — Illustrations  of  a  Transfer  Un- 
der Fiduciaries'  Powers — Lost,  Destroyed  or 
Stolen  Stock  Certificates — Transfer  Taxes — 
Negotiable  Instruments — Registered  Bonds — 
Coupon  Bonds — Transfer  and  Assignment  of 
Bonds — Coupons. 
"  "  •  Section  II.  Validity  and  Legality. 

IX.    INTEREST  RATES  AND  NET  YIELD  ON  BONDS 151 

Section  I.  The  Net  Interest  Yields — Obtain- 
ing the  Net  Yield  with  the  Use  of  the  Bond 
Table— Net  Yields  of  Unrecorded  Bond  Table 
Prices— The  Price  of  a  Bond  Where  the  Net 
Yield  Does  Not  Appear  in  the  Bond  Table — 
Use  of  Bank  Discount. 


TABLE  OF  CONTENTS  rv 

CHAPTER  PAGE 

Section  II.  Book  Values  on  Interest  Pay- 
ment Dates  of  Bonds  Purchased  at  a  Premium 
— Book  Values  on  Interest  Payment  Dates  of 
Discount  Bonds — Bonds  Purchased  on  Other 
Than  Interest  Dates — The  Serial  Bond 
Schedule. 

X.    MARKET  INFLUENCES  ON  SECURITY  PRICES 168 

Interest  and  Discount  Rates — Loans,  De- 
posits, and  Reserves — Bank  Clearings — Im- 
port and  Export  of  Gold — Miscellaneous  Fac- 
tors. 

XI.    MARKET     INFLUENCES     ON     SECURITY    PRICES 

(Cont'd)    186 

Seasonal  Variations — The  Business  Cycle — 
Fluctuations  in  Individual  Security  Prices — 
Rising  and  Falling  Prices  and  Their  Relation 
to  Investment  Yields. 

XII.    REGULATION  OF  THE  ISSUANCE  OF  SECURITIES 198 

The  General  Problem — Publicity — Blue  Sky 
Laws — Certification  of  Civil  Loans — State 
Regulation  of  Public  Utility  Issues. 

XIII.    TAXATION  OF  SECURITIES  21 8 

The  Basis  Upon  Which  the  Security  Tax  Is 
Levied— The  Effect  of  the  Tax  Levy— The 
More  Common  Methods  of  Taxing  Mortgages, 
Bonds,  and  Other  Securities — The  Place  of 
Taxation  for  the  Holder — Incidence  of  Taxa- 
tion of  Intangibles  (Securities) — Exemptions. 


BOOK  II 

CORPORATION  BONDS 

XIV.    RAILROAD  BONDS:  PHYSICAL  FACTORS,  TRAFFIC 

STATISTICS,  AND  REGULATION 245 

Physical     Determinates  —  Mileage  —  Equip- 


xvi  TABLE  OF  CONTENTS 

CHAPTER  PAGE 

ment — Passenger  and  Freight  Traffic — Traffic 
Density — Trainload  and  Carload — Terminals 
— Kegulation  and  Control. 

XV.    RAILROAD  BONDS   (Continued) :    REVENUES  AND 

EXPENDITURES  267 

Income  and  Expenditures  Accounts — Operat- 
ing Revenues — Operating  Expenses — Main- 
tenance of  Way — Maintenance  of  Equipment 
— Transportation  and  Other  Expenses — Ope- 
rating Ratio  —  Net  Operating  Revenue — 
Taxes — Other  Income — Net  Corporate  In- 
come— Distribution  of  the  Current  Surplus. 

XVI.    RAILROAD  BONDS   (Continued) :    THE  BALANCE 

SHEET  AND  CAPITAL  ACCOUNTS  293 

The  Property  Account — Current  Accounts 
— Liabilities  and  Capitalization. 

XVII.    RAILROAD  EQUIPMENT  SECURITIES 313 

The  Origin — Classification — Trust  Deed — 
Duration  and  Terms  of  Payment — Physical 
Factors  of  Equipment — Depreciation — Main- 
tenance and  Renewals — Insurance — Invest- 
ment Position. 

XVIII.    STREET  RAILWAYS  AND  INTERURBAN   TRACTION 

COMPANY'S  BONDS 328 

History  of  Urbasn  Companies — Consolidation 
with  Other  Public  Utilities — Population  Dis- 
tribution and  Its  Effect  on  Traffic — Density 
of  Traffic — Special  Problems  of  the  Interur- 
ban — Revenues  and  Costs  of  Operating. 

XIX.    STREET   RAILWAY   AND   INTERURBAN    TRACTION 

COMPANY  BONDS  (Continued)    350 

Technical  Units  of  Measurement  and  Com- 
parison— Capital,  Capitalization,  and  Prop- 
erty Investment — Depreciation — The  Fran- 
chise —  Regulation — General  Characteristics 
of  Bonds. 


TABLE  OF  CONTENTS  xvii 

CHAPTER  PAGE 

XX.    ELECTRIC  LIGHT  AND  POWER  BONDS 369 

Population,  Physical  Factors,  and  Territory 
Served — Capital,  Capitalization,  and  Prop- 
erty Accounts  —  Depreciation  —  Earnings — 
Costs  and  Peak  Load — Rates — Some  General 
Characteristics  of  the  Franchise — The  Market 
for  Electrical  Securities. 

XXI.    GAS  COMPANY  BONDS 388 

History  and  Present  Position — Industrial 
Uses  and  By  Products — Population  and  Its 
Relation  to  Service — Gas  Rates — Earnings 
and  Cost  of  Production — Capitalization  and 
Property  Accounts — Depreciation — Special 
Features  of  the  Gas  Franchise — Bond  Char- 
acteristics, Character,  Market,  and  Yield. 

XXII.    HYDRO-ELECTRIC  POWER  BONDS  407 

Development — Character  of  the  Business  and 
the  Market — Competition — Water  Supply, 
Storage,  and  Pondage — Riparian  Rights — 
Public  Regulations  of  "Water  Power — Con- 
struction Costs — Earnings  and  Operation 
Costs — Market  and  Bond  Characteristics. 

XXIII.  PRIVATE  WATER  COMPANY  BONDS 425 

Territory  and  Population — Supply  and  Qual- 
ity of  Water — Plant  and  Equipment — De- 
preciation— Capitalization  and  Earnings — 
Franchise — Bond  Market  and  Characteristics. 

XXIV.  TELEPHONE  AND  TELEGRAPH  SECURITIES 435 

Advantages  of  Large  Organization — Cost  of 
Construction  and  Operation  —  Depreciation 
and  Maintenance — Rates — Bond  Character- 
istics and  Market. 

XXV.    GREAT  LAKES  STEAMSHIP  BONDS 447 

General  Characteristics — Classes  of  Bonds — 
Physical  Properties  —  Financial  Status  — 


XV111 


•CHAPTER 


TABLE  OF  CONTENTS 


PAGE 

Trust  Deed — Insurance — Michigan  and  Ohio 
Laws — Denomination,  Duration  and  Yield. 

XXVI.    INDUSTRIAL  BONDS 455 

Character  and  Size  of  Business — Competition 
— Management — Fixed  Property  Account — 
Depreciation  —  Maintenance  —  Goodwill — 
Working  Capital — Sales,  Earnings,  and  Ex- 
penses— Legal  Status  of  Industrial  Securities 
— Possibilities  in  Industrial  Bonds. 

XXVII.     TIMBER  BONDS 469 

Supply  and  Consumption  of  Timber — Con- 
trol of  the  Timber  Supply — Legal  Prerequi- 
sites— Fire  Risks — The  Timber  Cruiser's 
Valuation — Balance  Sheet  and  Income  State- 
ment— The  Market. 


BOOK  III 

BONDS  SECURED  BY  LAND  OR  REAL  ESTATE 

XXVIII.    REAL  ESTATE  MORTGAGES 483 

Appraising  of  Real  Estate  Values — Appreci- 
ation of  Land — The  Effect  of  Structure 
Values — Depreciation  of  Building — Build- 
ing as  Related  to  Demand  of  Locality — Cost 
of  Operating  Property — Margin  of  Loan — 
Taxation  of  Mortgage — Convertibility  and 
Hypothecation — Denomination,  Maturity  and 
Yield. 

XXIX.    REAL  ESTATE  BONDS 496 

Classification — Real  Estate  Mortgage  Bonds 
— Debenture  Mortgage  Bonds — Leasehold 
Mortgage  Bonds  —  Installment  Payment 
Plans — Trust  Agreement  of  the  Company — 
Convertibility — Other  Miscellaneous  Charac- 
teristics. 


TABLE  OF  CONTENTS 


xix 


CHAPTER 

XXX. 


XXXI. 


XXXII. 


XXXIII. 


XXXIV. 


PAGE 

FARM    MORTGAGE   AND   FEDERAL   FARM   LOAN 

BONDS 507 

History  of  Development — Increase  in  Land 
Values — Location  and  Distribution — Classes 
of  Farm  Securities — Physical  Appraisement 
— Other  Miscellaneous  Factors — Period  of 
Redemption  after  Foreclosure — Farm  Loan 
Bonds. 

IRRIGATION  SECURITIES 526 

Municipal  Irrigation  District  Bonds — Carey 
Act  Bonds — Private  Corporation  Bonds — 
Security  of  Irrigation  Bonds — Water  Supply 
Land  Title — Costs — Capitalization — Working 
Capital  Eequirements  for  Settlers — Market. 

DRAINAGE  AND  LEVEE  BONDS 539 

General  Characteristics — Organization  of  Dis- 
tricts— Security — Taxes — The  Market. 


BOOK  IV 

CIVIL  OBLIGATIONS 

THE  ISSUING  POLITICAL  UNIT  AND  THE  SECURITY 

OF  ITS  BOND  ISSUES 549 

Jurisdiction  and  Function  of  Civil  Divisions 
as  Related  to  the  Powers  to  Finance  Them- 
selves— Physical  Resources — Financial  Re- 
sources— Other  Resources — Population — The 
Financial  History  and  Integrity  of  the  Civil 
Unit. 

VALUATION,  TAX  RATE,  AND  VALIDITY  AS  RE- 
LATED TO  CIVIL  LOANS 564 

Valuation — Taxation  and  the  Tax  Rate — 
Rate — Creation  of  the  Special  Tax  District 
— Legality  and  Validity. 


xx  TABLE  OF  CONTENTS 

CHAPTER  PAGE 

XXXV.    THE  DEBT  OP  THE  CIVIL  DIVISION 582 

The  Funded  Debt— Other  Debts— The  Actual 
Debt  Per  Capita— The  Net  Debt— Debt  Re- 
strictions — Duration  of  the  Funded  Debt — 
— Payment  of  the  Debt — Repudiation  of  the 
Debt. 

XXXVI.    SPECIAL  FACTORS  AFFECTING  THE  MARKET  AND 

PRICE  OF  CIVIL  OBLIGATIONS 606 

The  Market — Protection  to  the  Investor  in 
Certification — The  Purpose  of  Issue  vs.  Mar- 
ket Price — Denomination  and  Duration — 
Civil  Loans  as  Collateral — Their  Converti- 
bility— Tax  Exemption. 

XXXVII.  UNITED  STATES  GOVERNMENT  BONDS 622 

Summary  of  the  History  of  the  United  States 
Bond  Debt — Security  of  National  Bonds — 
Wealth  and  Income  of  the  United  States — 
The  Circulation  Privilege — Kate,  Amount, 
Denomination  and  Taxation — The  Markets, 
Prices,  and  Net  Yield. 

XXXVIII.  FOREIGN  GOVERNMENT 648 

What  Determines  the  Flow  of  Investment 
between  Countries — The  Character  of  the 
Money  System  and  Its  Effect  on  the  National 
Debt — Forms  of  Indebtedness — Repudiation 
and  Defalcation  —  Foreign  Investment 
Trusts — The  American  Market  for  Foreign 
Securities — Price  of  Government  Bonds. 


APPENDIX 

A.    CATALOGUE  OF  BONDS  . 


675 


B.  TABLE  OF  THE  PRESENT  OUTST \NDING  LIBERTY  BONDS 
OF  THE  UNITED  STATES  TOGETHER  WITH  THEIR 
IMPORTANT  REGULATIONS 698 


TABLE  OF  CONTENTS 


xxi 


PAGE 

C.  INCOME  ANALYSIS  OF  THE  AMERICAN  TELEGRAPH  AND 

TELEPHONE  COMPANY 702 

D.  SUGGESTED  TOPICAL  BIBLIOGRAPHY 703 

INDEX  . .  775 


BOOK  I 

GENERAL  FUNDAMENTALS  AND  THEIR 

APPLICATION    IN    THE    ANALYSIS 

OF  INVESTMENT  SECURITIES 


CHAPTER  I 
INTRODUCTION— THE    MEANING    OF    INVESTMENTS 

It  may  seem  like  a  contradiction  to  begin  a  book  on  invest- 
ments by  recommending  that  the  investor  first  and  last  seek 
the  advice  of  an  investment  banking  house.  "Why  bother," 
the  reader  asks,  "to  obtain  an  understanding  of  security  values, 
if  in  the  end  the  advice  of  the  investment  banker  must  be 
sought?"  It  is  only  when  the  investor  has  a  full  appreciation 
of  the  requirements  of  sound  investments  that  he  will  always 
seek  the  advice  of  his  banker,  and  then  follow  this  advice  when 
given.  The  investment  banker  who  judiciously  attempts  to  meet 
the  particular  needs  of  every  client  can  best  appreciate  this 
fact.  After  the  most  conscientious  and  discriminating  explana- 
tion of  the  advantages  a  certain  security  possesses  for  a  par- 
ticular client,  the  banker  may  find  his  recommendation  thrown 
aside,  because  his  client  has  over-emphasized  insignificant  fac- 
tors. Such  errors  are  the  result  of  an  ignorance  of  security 
values  and  not  the  result  of  an  excessive  knowledge  of  invest- 
ments. The  investor  who  really  knows  the  factors  that  are 
essential,  also  best  realizes  his  own  limitations.  Contrary  to  the 
belief  of  many  that  there  is  a  decreasing  need  of  the  banker 
who  is  a  real  expert,  there  will  be  an  increasing  demand  for  his 
services  as  a  general  understanding  of  the  fundamentals  of 
investment  increases.  The  service  that  he  renders  to  his  clien- 
tele will  be  of  more  specific  value  and  his  advice  will  also  be 
followed  more  closely. 

Regardless  of  how  proficient  the  investor  may  become  in 
analyzing  investment  data,  he  must  secure  the  larger  part  of 
his  material  from  his  banker,  for  the  information  of  the  banker 
who  offers  the  securities  for  sale  should  be  the  more  reliable. 
Further,  it  is  not  only  unprofitable,  but  impossible,  for  the 
average  investor  to  pay  for^the  organization  necessary  to  gather 

3 


4  INVESTMENT    ANALYSIS 

the  facts  for  the  detailed  examination  necessary  to  determine 
the  value  of  any  particular  security.  The  investment  banker, 
on  the  other  hand,  who  has  continual  need  of  this  service,  can 
afford  to  maintain  a  staff  of  experts  to  gather  data. 

Naturally,  this  reliance  which  must  be  placed  in  the  invest- 
ment banker's  judgment  and  the  facts  which  he  gives,  necessi- 
tates a  careful  selection  of  a  banker  on  the  part  of  the  investor. 
There  are  a  small  number  of  bankers  who,  though  honest,  do 
not  have  the  knowledge  and  experience  necessary  to  make  the 
rigid  analysis  essential  for  determining  the  value  of  invest- 
ments; and  as  a  result  often  offer  highly  speculative  securities 
as  investments.  Lastly  there  is  even  a  smaller  class  of  so-called 
bankers  who,  because  of  the  ease  with  which  securities  of  doubt- 
ful repute  can  be  sold  under  the  blind  of  a  well-worded 
prospectus,  are  able  to  sell  their  securities  to  the  uninitiated. 
And  further,  because  of  this,  the  importance  of  the  selection  of 
a  well-known,  reputable  investment  banker  becomes  all  the  more 
evident.  In  the  correction  of  questionable  practices  of  the 
latter  class,  the  Investment  Bankers'  Association  has  done  a 
great  deal  and  it  will  become  increasingly  strong  in  its  control.1 
Experience  has  shown  that  no  control  is  so  effective  as  the 
voluntary  control  of  an  organization  itself,  when  that  organi- 
zation represents  wide  and  diversified  interests. 

The  great  pioneering  period  with  its  attendant  stimulus  to 
speculation  is  passing,  and  we  are  settling  into  the  slower 
growth  of  the  established  community.  Keener  competition, 
greater  efficiency  in  organization,  increasing  regulation,  and  the 
larger  compensation  demanded  by  labor — all  a  direct  result  of 
this  change — are  forcing  greater  care  and  skill  in  the  organi- 
zation of  new  industries.  A  few  exceptions  will  probably 
always  exist,  but  they  will  not  be  found  among  the  corporations 
whose  securities  are  included  in  the  so-called  investment  class. 
More  and  more,  conditions  are  compelling  the  investor  also  to 
recognize  the  necessity  of  a  more  careful  study  of  facts.  The 


Commendation  also  should  be  made  of  the  efforts  of  the  Investment 
Bankers'  Association  in  educating  its  own  members  along  technical  lines. 
The  work  which  this  Association  is  doing  in  this  regard  is  not  fully 
appreciated  outside  the  Association  itself,  though  it  will  prove,  even- 
tually, to  be  among  the  most  effective  and  permanent  of  its  efforts. 


INTRODUCTION  5 

prospective  purchaser  of  investment  securities  is  no  longer  con- 
tent with  only  the  promise  of  a  rhetorical  prospectus  as  a  basis 
for  determining  the  value  of  his  investments.  He  has  come  to 
appreciate  that  there  are  underlying  causes  for  the  continued 
stability  and  large  earnings  of  a  corporation. 

Before  passing  on  to  the  discussion  of  the  meaning  of  invest- 
ments, two  things  need  to  be  particularly  emphasized  to  the 
beginning  student  of  investment  securities.  First,  in  all 
sciences,  the  analysis  must  begin  with  the  underlying  or  basic 
phenomena  before  proceeding  to  the  variations.  Secondly, 
almost  every  analysis  of  an  investment  security  necessitates 
some  variation  in  the  application  of  the  principles.  This  is  a 
fact  which  is  commonly  ignored.  While  every  analysis  must 
begin  with  fundamentals,  no  treatise  on  science  can  give  a 
complete  set  of  rules  which  will  measure  everything  with 
finality.  Not  even  the  much  older  and  more  exact  science  of 
engineering  ever  attempted  to  do  this.  And  only  long  experi- 
ence and  constant  study  can  give  skill  and  astuteness  in  the 
application  of  these  principles.  The  mistake,  as  previously 
stated,  is  that  beginners  often  painfully  attempt  to  apply  to  all 
securities  the  same  rigid  ''rule  of  thumb"  measurement.  Most 
often  this  mistake  is  due  to  the  beginner 's  lack  of  understanding 
of  the  principle.  Practical  problems  are  continually  changing; 
no  "rule  of  thumb"  can  be  used  offhand  to  decide  them,  though 
the  starting  point  for  the  development  of  the  most  complicated 
analysis  is  the  fundamental  principle. 

As  in  all  subjects  in  the  field  of  applied  economics  or 
business,  considerable  information  has  been  acquired  by  the 
beginner  from  one  source  or  another.  "With  the  majority, 
this  information  has  not  been  subjected  to  any  classification 
in  accordance  with  the  relative  importance  of  facts.  Conse- 
quently, many  cleverly  worded  explanations,  based  upon  sta- 
tistical evidence  and  juggled  to  meet  present  needs,  are  accepted 
as  truth,  or  more  often  conclusions  are  made  which  were 
never  intended  by  the  seller  of  the  securities.  Ignorance 
of  the  essentials  in  the  analysis  of  securities  also  frequently 
leads  to  a  disregard  of  the  most  vital  material.  The  reader  who 
has  acquired  these  habits  of  loose  reasoning  is,  of  course,  in 


6  INVESTMENT   ANALYSIS 

more  need  of  close  observation  of  his  conclusions  on  investment 
values  than  the  beginner  who  has  no  preconceived  ideas  on  the 
subject.  One  of  the  most  difficult  things  for  the  American 
student  whose  knowledge  of  any  applied  subject  in  business 
has  been  acquired  in  this  haphazard  way  and  without  direction, 
is  to  begin  with  the  fundamentals.  Where  the  previous 
information  and  viewpoint  of  a  student  have  been  developed 
under  a  sound  system  of  methodology,  incomplete  as  his  informa- 
tion may  be,  it  must  serve  as  a  very  valuable  aid  in  a  study  of 
any  of  the  applied  subjects  of  economics.  "What  is  considered 
here  must  not,  however,  be  taken  as  a  substitute  for  actual 
experience.  No  far-reaching  grasp  of  investment  problems  can 
be  acquired  until  experience  has  taught  the  investor  the  true 
appreciation  of  the  correct  application  of  principles. 

To  establish  sound  and  careful  thinking,  it  is,  of  course, 
necessary  to  proceed  first  from  the  simplest  and  most  exact 
investment  and  its  underlying  principles,  to  the  broader  appli- 
cation of  these  principles.  No  teacher,  in  expounding  the  laws 
of  supply  and  demand  in  their  simplest  form — namely,  a  purely 
competitive  state — ever  considers  concluding  his  exposition  at 
that  point.  On  the  other  hand,  any  student  of  economics  in 
the  future  who  desires  to  have  a  clear  understanding  of  supply 
and  demand  must  thoroughly  comprehend  their  fundamentals, 
regardless  of  how  few  prices  under  non-regulation  conform 
to  the  law  for  price-fixing  or  how  many  prices  are  controlled 
by  the  government. 

Few  securities  absolutely  conform  to  the  fundamental  prin- 
ciples of  investments  laid  down  in  the  succeeding  chapter. 
Once,  then,  the  principles  are  established,  there  seems  to  be  no 
more  purpose  in  confining  any  discussion  of  investments  to 
securities  that  rigidly  conform  to  all  requirements,  than  there 
is  in  confining  a  discussion  of  the  laws  of  supply  and  demand 
to  a  purely  competitive  regime.  While  some  of  the  first  rank 
bonds  comply  more  fully  than  any  other  type  of  security  with 
the  ideal  standards  of  investment,  there  are  other  securities 
which,  although  they  do  not  possess  all  the  requirements  of  an 
ideal  investment,  are  more  desirable  than  some  bonds.  It  is 
with  this  practical  viewpoint  of  sound  investments  that  this 
volume  is  concerned. 


INTRODUCTION  7 

What  the  Field  of  Investments  Includes. — It  is  not  always 
an  easy  task  to  give  a  comprehensive  definition  at  the  beginning 
of  a  treatise.  Any  statement  of  the  premises  of  a  subject,  and 
particularly  in  the  field  of  economics,  is  always  better  understood 
when  the  subject-matter  has  been  covered  and  a  perspective 
viewpoint  obtained.  What  the  field  of  investments  includes  can 
probably  be  best  stated  by  distinguishing  it  from  speculation, 
for  speculation  is  frequently  confused  with  investments. 

The  most  fundamental  distinction  between  investment  and 
speculation  rests  in  the  difference  in  the  purpose  of  the  pur- 
chase. The  investor  buys  to  procure  the  income  from  the  prin- 
cipal, while  the  speculator  buys  to  secure  the  profits  that  may 
accrue  in  a  realized  appreciation  of  the  principal.  In  order 
for  an  investment  to  be  assured  of  a  continued  income,  danger 
of  all  losses  or  any  considerable  fluctuation  in  value  of  a  secur- 
ity must  be  eliminated.  This  requirement  establishes  the  second 
distinction  between  investment  and  speculation.  Investment 
minimizes  risk;  speculation  emphasizes  risk.  Greater  risks  are 
essential  to  the  latter,  if  profits  are  to  be  procured  from  a  fluc- 
tuation of  security  prices.  It  is  true  that  risk  is  always  present 
in  a  varying  degree  and  the  distinction  between  these  different 
risks  often  is  correspondingly  more  or  less  arbitrary — though  in 
the  search  for  an  investment,  the  constant  effort  is  to  eliminate 
the  risk.  The  speculator,  on  the  other  hand,  is  always  con- 
sciously assuming  risk,  and  his  studied  efforts  are  to  take 
advantage  of  what  he  concludes  to  be  the  final  effect  of  the  risk 
on  the  price  of  the  security. 

The  speculator  is  interested  only  in  the  temporary  success 
of  the  income  yield  which  will  force  a  change  in  prices,  while 
the  investor  must  be  assured  of  the  future  permanency  of  this 
income.  The  greater  the  assurance  that  the  income  will  remain 
fairly  constant  and  permanent,  the  less  chance  will  there  be 
for  quick  speculative  turnovers.  To  the  degree  that  the  latter 
holds  true,  the  security  will  be  less  desirable  to  the  speculator 
wanting  large  speculative  gains.  The  evidence  of  this  is  shown 
in  the  small  amount  of  speculation  in  the  best  investment  bonds, 
except  during  periods  of  business  depression.  The  most  suc- 
cessful speculator,  however,  ts  one  who  has  the  keenest  under- 
standing of  possible  investment  values  as  well  as  of  the  external 


8  INVESTMENT    ANALYSIS 

movements  of  the  market.  With  this  knowledge  he  is  able  to 
analyze  the  more  accurately  all  causes  that  may  temporarily 
change  the  trend  of  security  prices.  On  the  other  hand,  it  does 
not  follow  that  a  shrewd  investor  may  not  be  a  clever  speculator. 

The  distinction,  as  is  now  well  seen,  cannot  be  made  iron- 
clad. No  one  has  been  able — and  probably  no  one,  with  the 
most  accurately  worded  definition,  will  ever  be  able — to  draw  a 
hard  and  fast  distinction  between  investment  and  speculation. 
Despite  this  border  line  between  the  two,  there  is  a  demarcation 
outside  of  this  line,  which  any  one  with  a  complete  under- 
standing of  investment  principles  does  not  fail  to  recognize. 
For  all  practical  purposes  this  is  quite  sufficient. 

The  Scope  and  Limitations  of  This  Study. — It  is  only  in  the 
last  two  decades  that  any  serious  attempt  has  been  made  to 
formulate  and  draw  up  the  principles  of  investment.  In  the 
three  or  four  books  published  in  this  period  which  have 
attempted  a  scientific  treatment,  the  method  of  approach  has 
differed  materially.  To  a  degree  this  must  always  be  true  in 
any  subject,  although,  as  principles  become  well  formulated, 
there  will  not  be  a  very  wide  difference  in  the  method.  Both 
the  functional  and  the  topical  method  of  analysis  have,  been 
used  in  this  text  and  the  author  has  arbitrarily  passed  from  one 
method  to  the  other,  as  seemed  best  suited  to  the  simplest  and 
most  adequate  treatment  of  each  particular  subject. 

The  subject-matter  of  the  text  has  been  grouped  into  the 
four  main  divisions:  (1)  General  Fundamentals  in  the  Analysis 
of  Securities;  (2)  Corporation  Securities;  (3)  Securities 
Dependent  Primarily  on  Land  and  Eeal  Estate,  and  (4)  Civil 
Loans.  The  functional  form  of  analysis  has  been  followed  in 
numbers  one  and  four  of  these  divisions  with  the  exception  of 
the  last  two  chapters  in  division  four.  In  divisions  two  and 
three  because  of  the  great  differences  existing  between  the  vari- 
ous types  of  securities,  the  logical  treatment  seems  to  call  for 
the  topical  method  of  analysis.  While  Civil  Loans,  comprising 
division  four,  might  be  treated  by  the  topical  method  based 
upon  the  various  classes  of  the  political  divisions,  the  avoidance 
of  a  great  amount  of  duplication  where  the  same  principles 
apply  to  all  classes  of  civil  loans  has  been  accomplished  by  the 


9 

functional  treatment.  This,  consequently,  seems  the  most  con- 
sistent method  of  approach  for  the  beginner.  Though  certain 
details  may  vary,  the  principles  of  valuation,  tax  rates,  debt 
limitations,  etc.,  are  the  same  whether  applied  to  state  bonds, 
city  bonds,  or  other  types.  Because  of  the  greater  simplicity  of 
treatment,  all  of  the  subject-matter  applying  to  investments  in 
general  has  been  placed  under  the  first  group  of  topics. 

Under  the  first  main  division  of  the  book,  the  General 
Fundamentals  in  the  Analysis  of  Securities  are  treated.  Firstly, 
the  now  generally  accepted  principles  which  govern  a  sound 
investment  are  presented.  Secondly,  a  complete  classification 
of  bonds  and  mortgages  has  been  made  to  show  that  securities 
are  issued  for  different  purposes,  and  have  different  maturity 
dates,  interest  rates  and  liens,  different  claims  against  a  prop- 
erty, and  different  relations  to  other  claims.  This  reduces  to  as 
simple  a  working  basis  as  possible,  the  several  hundred  differ- 
ent kinds  of  instruments.  Thirdly,  two  chapters  present  the 
more  important  phases  of  the  corporation  report.  Fourthly, 
the  mortgage  which  underlies  the  bond  is  outlined  in  consid- 
erable detail,  setting  forth  the  essentials  necessary  for  the  com- 
plete protection  of  the  bondholder.  This  is  followed  by  a 
general  brief  upon  the  negotiation,  issuance,  assignment  and 
transfer  of  securities.  Sixthly,  two  chapters  are  devoted  to  a 
study  of  the  market.  In  these  chapters  are  discussed  such  topics 
as  bank  loans,  interest  rates,  rising  and  falling  prices,  etc.,  and 
their  effect  upon  security  prices.  Seventhly,  one  chapter  is  de- 
voted to  the  regulation  of  security  issues  and  one  to  taxation. 

The  second  division,  comprising  Corporation  Loans,  treats  of 
the  various  types  of  Corporation  bonds.  They  are  divided  and 
discussed  in  the  following  order:  railroads  (three  chapters), 
railroad  equipment,  street  railway  and  interurban,  electric  light 
and  power,  hydro-electric  power,  gas,  private  water  companies, 
steamship,  industrial  and  timber  securities. 

The  securities  under  the  third  division  which  have  their 
main  security  dependent  upon  land  are  likewise  treated  as  cor- 
poration loans.  The  importance  of  land  or  real  estate  and  the 
problems  peculiar  to  this  form  of  security  seem  to  warrant  this, 
separation.  In  this  division  are  included:  real  estate  mort- 


10  INVESTMENT   ANALYSIS 

gages,  real  estate  bonds,  farm  mortgages,  irrigation  bonds  and 
levee  and  drainage  bonds.  As  the  majority  of  the  two  latter 
types  of  securities  are  issued  by  municipal  district  organizations, 
they  might  well  be  classed  under  the  division  of  Civil  Loans. 
But  again  the  peculiar  character  of  the  security  of  these  bonds 
seems  to  justify  this  division. 

Civil  Loans,  the  third  and  the  last  of  the  main  divisions  of 
the  book,  includes  the  study  of  the  United  States,  state,  county, 
city,  town,  special  assessment  and  other  forms  of  special  civil 
loan  bonds.  Because  of  the  importance  of  the  European  loans 
which  have  occupied  a  prominent  place  in  the  investments  of 
this  country  since  1914,  a  chapter  has  been  included  on  these 
securities,  the  conclusion  of  which  deals  with  those  conditions 
that  will  particularly  affect  the  holder  of  foreign  securities. 
As  stated  above,  with  the  exception  of  the  discussion  of  the 
United  States  bonds,  the  functional  treatment  of  civil  loans 
seems  to  offer  the  most  comprehensive  method  of  approach  to  an 
understanding  of  these  securities.  The  preponderant  emphasis 
which  must  necessarily  be  placed  on  the  legal  aspects  of  these 
securities  quite  separates  them  from  corporate  loans.  While 
income  safety  requirements,  etc.,  must  be  given  the  same  impor- 
tance, the  emphasis  and  the  method  of  approach  are  quite 
different  from  those  employed  in  the  discussion  of  corporate 
loans.  The  information  contained  in  these  pages  is  what  the 
counsel  of  a  conservative  bond  house  would  use  as  the  basis 
for  the  analysis  of  these  securities.  No  attempt  has  been  made 
to  go  into  all  the  legal  ramifications  and  details  which  it  is 
necessary  for  the  attorney  to  know,  but  all  the  fundamental 
principles  upon  which  the  attorney  must  build  his  legal  decision 
and  his  completed  report  are  included. 

National  loans  offer  a  very  different  problem.  These  loans 
are  dependent  wholly  upon  the  sovereign  will  of  the  state.  A 
study  of  the  safety  of  these  loans  must  be  a  study  of  the  state 's 
good  faith  and  its  ability  to  maintain  this  good  faith.  The 
huge  proportion  of  war  loans  and  the  emphasis  which  has  been 
placed  upon  certain  types  of  foreign  bonds  have  led  many  to 
believe,  as  previously  intimated,  that  foreign  national  issues  are 
peculiar.  Quite  true,  the  variation  in  size  and  conditions  under 


INTRODUCTION  11 

which  the  national  loan  must  be  made  will  require  a  different 
emphasis,  but  the  fundamentals  determining  safety  are  no 
different. 

In  conclusion  the  author  desires  to  emphasize  that  the  pur- 
pose of  the  book  is  the  analysis  of  investment  securities,  rather 
than  a  mere  statement  of  the  principles.  This  has  necessitated 
in  the  discussion  of  many  points,  a  consideration  of  accounting, 
corporation  finance  and  law.  If  the  mere  treatment  of  invest- 
ment principles  had  been  considered — this  would  not  have  been 
necessary — but  no  real  analysis  of  investments  can  eliminate 
them.  It  is,  however,  extremely  difficult  to  draw  the  border 
line  between  these  respective  fields  and  any  one  who  would  write 
upon  the  subjects  of  investments  would  utilize  the  material  in 
these  respective  fields,  of  course,  to  a  varying  degree.  But  one 
thing  certain,  if  an  analysis  is  to  be  made,  large  use  of  these 
fields  must  be  made  or  the  analysis  will  fall  far  short  of  what 
it  should  give. 

The  aim  of  this  brief  has  been  to  set  forth  a  short  statement 
indicating  the  purpose  of  this  book,  the  boundaries  of  the  sub- 
ject, and  the  limitations  to  which  it  must  be  confined.  With 
this  statement  of  the  purposes  of  the  text  we  proceed  at  once  in 
the  next  chapter  to  an  examination  of  the  principles  of  invest- 
ment securities. 


CHAPTER  II 
GENERAL  PRINCIPLES  OF  INVESTMENTS 

The  fundamental  elements  in  the  selection  of  an  ideal  invest- 
ment, are:  (1)  safety  of  principal;  (2)  certainty  of  income;  (3) 
rate  of  income;1  (4)  legality;  (5)  stability  of  market  price;  (6) 
marketability;  (7)  appreciation;  and  (8)  diversification.2  Any 
security,  to  be  classed  as  an  investment,  must  in  a  measure  ful- 
fill all  these  requirements,  though  no  security  will  be  found  pos- 
sessing them  in  perfect  equality.  However,  the  same  elements 
are  not  equally  essential  to  all  investors,  and  to  pay  for  what 
is  not  needed  means  a  needless  sacrifice  of  income.  Also,  a 
demand  for  an  increased  ratio  of  any  one  of  these  elements  will 
result  in  a  corresponding  decrease  in  the  others.  It  is  abso- 
lutely necessary,  for  example,  that  the  investment  of  a  business 
surplus  have  a  very  high  degree  of  convertibility.  But,  as 
greater  convertibility  means  a  lower  rate  of  return,  it  would 
be  unnecessarily  costly  for  the  trustee  of  a  widow's  estate  to 
place  the  same  emphasis  on  this  element  as  would  the  investor 
of  a  business  surplus.  The  trustee  would  then  be  lowering  the 
rate  of  return,  and  also  be  paying  for  something  the  estate  does 
not  need. 

The   investment   of   insurance   company   reserves,    banking 


'The  first  two  of  these  principles,  which  deal  directly  with  the  indi- 
vidual security  and  its  value,  must  be  determined  by  the  analysis  of 
the  corporation  issuing  the  securities,  and  are  treated  in  Books  II  and 
III.  The  legality  of  securities  is  covered  in  chapters  vi.  vii.  and  viii  of 
Book  I,  and  further  consideration  is  given  to  Stability  of  Market  Price, 
Marketability,  Appreciation,  and  Diversification,  in  chapters  x  and  xi 
of  Book  I. 

2If  the  topics  of  this  chapter  were  treated  as  Lawrence  Chamberlain 
has  analyzed  them  in  his  Principles  of  Bond  Investment  (chapter  iii) 
under  the  heading  of  the  "Ideal  Elements  of  Investments,"  rather  than 
"General  Principles."  the  topics  of  tax  exemption,  acceptable  duration 
and  acceptable  denomination,  value  as  collateral,  and  exemption  from 
eare,  could  well  be  included.  As  a  complete  chapter  is  devoted  to  the 
taxation  of  securities,  no  reference  is  made  to  it  in  this  chapter. 

12 


PRINCIPLES  OF  INVESTMENTS  13 

funds,  business  surplus,  widows'  and  orphans'  estates,  etc.,  each 
have  their  own  peculiar  needs,  which  can  be  met  with  a  result- 
ing advantage  to  the  funds  affected.  Consequently,  an  under- 
standing of  investment  principles  is  needed  to  enable  each  pur- 
chaser to  select  the  investment  best  suited  to  his  requirements. 

Safety  of  Principal  and  Income. — Of  all  elements,  that  of 
safety  is  the  first  requirement  in  any  investment.  The  history 
of  a  large  number  of  securities  bears  evidence  that  safety  of 
principal  is  practically  possible.  Whatever  the  purpose  of  the 
investment,  safety  must  not  be  sacrificed,  though  the  demand 
for  even  this  element  may  be  carried  to  an  extreme.  For  illus- 
tration, the  trustee  of  an  estate  who  prefers  Civil  Loans  might 
purchase  a  two  per  cent  United  States  bond,  while  a  municipal 
bond  yielding  five  per  cent  would  have  insured  the  necessary 
security,  while  bringing  a  higher  rate  of  return. 

Safety  must  not  be  confused  with  the  selling  value  of  prop- 
erty. The  investor  is  interested  in  earning-power.  Many  pur- 
chasers of  bonds  have  drawn  the  conclusion  that  because  a  bond 
is  a  specific  lien  it  is  secure.  The  value  of  the  property  as 
security  of  the  bondholder  depends  upon  the  property  as  a 
going  concern.  "Even  after  the  bondholder  has  exercised  his 
rights  of  foreclosure,  he  finds  that  the  value  of  his  security  still 
depends  on  what  the  properties  can  earn  for  him.  And  this 
earning  power  should  be  determined  on  a  minimum  basis." 

Safety  of  principal  and  income  are  normally  interdependent. 
Ability  to  meet  interest  payments  regularly,  usually  indicates 
the  possession  of  property  of  some  value.  Where  considerable 
irregularity  occurs  in  the  tenancy  of  the  property,  bonds  or 
mortgages  upon  real  estate  possessing  margins  ample  to  insure 
absolute  safety  of  principal,  will  not  necessarily  give  the  same 
assurance  of  safety  of  income  as  do  state  or  first  class  railroad 
bonds.  On  the  other  hand,  in  some  states  it  is  still  possible  for 
municipal  bonds,  issued  under  certain  conditions,  to  lapse  in 
interest,  and  suit  can  be  brought  only  for  the  defaulted  interest 
payments.  Action  for  the  principal  can  be  brought  only  after 
the  date  of  its  maturity.  In  the  days  when  railroads  were 

'Spencer  Trask  &  Co.,  Unpublished  Lectures. 


14  INVESTMENT   ANALYSIS 

overly  anxious  to  obtain  control  of  a  large  number  of  subsidiary 
lines,  they  guaranteed  the  securities  of  these  subsidiary  proper- 
ties, a  practice  which  frequently  resulted  in  higher  prices  being 
paid  for  these  securities  than  was  justified.  This  supposed 
re-inforcement  of  credit  frequently  was  based  on  the  idea  that 
safety  of  principal  and  safety  of  income  were  synonymous. 
Needless  to  say,  the  uninitiated  has  too  frequently  accepted  a 
guarantee  as  an  assurance  of  absolute  safety.  The  value  of  the 
guarantee  depends,  first,  on  the  ability  of  the  company  to  meet 
its  charges  without  the  guarantee,  secondly,  upon  the  soundness 
of  the  guaranteeing  company,  which  means  its  ability  to  pay 
the  income. 

Rates  of  Income. — The  first  question  raised  by  the  individual 
using  the  proper  precaution  in  making  his  initial  investment  is : 
"What  rate  of  interest  can  be  expected  from  a  perfectly  safe 
investment?"  He  finds  at  once  that  the  rate  varies  with  the 
character  and  safety  of  the  company  upon  which  the  security 
is  placed,  the  newness  of  the  industry,  and  the  date  of  the  issue. 
While,  theoretically,  United  States  bonds  possess  a  higher  degree 
of  safety  than  the  state  bonds  of  New  York  or  Massachusetts, 
for  all  practical  purposes  the  securities  of  these  common- 
wealths possess  as  good  security  as  the  United  States  bonds  and 
formerly  under  normal  investment  conditions  paid  a  much 
higher  rate  of  return.  With  a  complete  return  to  normal  con- 
ditions, this  relationship  will  probably  again  prevail.  A  num- 
ber of  street  railways,  electric  light  and  gas  company  securi- 
ties, with  safety  equal  to  that  of  certain  railroad  securities,  pay 
a  higher  interest  return  than  the  railroads.  A  number  of 
industrial  securities  possessing  safety  equal  to  that  of  several 
public  utilities  of  the  first  rank  are  selling  on  a  higher  aver- 
age basis  than  these  same  public  utilities. 

Any  considerable  fluctuation  in  the  net  yield  of  a  strict 
investment  is  to  be  seriously  questioned.  As  Greene  points  out : 
"It  is  not  good  financing  to  sell  evidence  of  indebtedness  at  a 
heavy  discount,  even  though  the  stated  rate  of  interest  be  below 
the  usual  percentage.  It  is  better,  if  possible,  to  arrange  the 
rate  of  interest  so  that  the  bonds,  or  notes,  will  fetch  par.  .  .  . 
If  a  million  dollars  is  needed,  the  company  must  put  out 


PRINCIPLES  OF  INVESTMENTS  15 

$1,250,000  (4%  bonds)  at  80,  to  obtain  the  required  sum;  the 
interest  to  be  paid  annually,  meanwhile  being  the  same  as 
though  five  per  cent  bonds  were  issued  at  par.  .  .  .  If  it  (the 
issue)  requires  a  rate  of  interest  far  above  the  ruling  market 
to  enable  the  issue  to  fetch  par,  it  is  proof  that  the  amount  of 
principal  asked  for  is  too  large  for  the  business  to  support."1 

Until  1898,  interest  rates  steadily  declined,  and  the  net  yield 
of  investment  securities  was  correspondingly  lowered.  After 
this  date  interest  rates  slowly  followed  the  upward  trend  of 
the  general  price  level.  All  of  the  long-timed  bonds  issued  by 
the  nations  of  Europe  have  furnished,  because  of  the  very  long 
period  over  which  they  have  extended,  some  interesting  evidence 
of  the  influence  of  the  interest  rate  upon  the  prices  of  bonds. 
A  study  of  the  net  yields  of  the  long-termed  high-grade  bonds 
is  also  an  interesting  verification  of  the  response  to  the  chang- 
ing demand  for  an  increased  yield.  The  higher  the  character 
of  an  active  security  (of  the  so-called  investment  class),  the 
more  sensitive  it  is  to  the  changing  market  rates  of  interest. 
High-grade  bonds  which  have  no  attached  features  that  give 
them  an  artificial  market  are  thus  the  best  barometers  of  the 
influence  of  a  permanent  changing  market.  Though  the  fluc- 
tuations of  investment  securities  are  not  so  wide  as  in  the  more 
speculative  issues,  the  former  class  is  more  sensitive  and  rep- 
resent more  accurately  in  their  narrower  fluctuations  the  invest- 
ment market  demand.  The  influence  of  a  very  abnormal  situa- 
tion, such  as  the  recent  European  War  upon  municipal  security 
yield,  shows  that  the  conditions  applying  to  a  market  over  a  long 
period  may  also  hold  true  even  in  a  temporary  change  in  the 
market.2  With  the  breaking  out  of  the  war,  the  temporary 
scarcity  of  funds  and  the  timidity  of  investors  forced  the  yield 
of  municipal  bonds  to  unheard  of  heights;  but  with  the  unpar- 
alleled inflow  of  gold  into  the  United  States,  municipal  yields 
settled  to  low  records. 

Marketability. — Though  every  strictly  investment  security 
should  have  an  absolute  assurance  of  the  payment  of  its  prin- 


'Thomas    L.    Greene,    Corporation   Finance,    Third    Edition     (1913, 
pp.  5-6). 

2For  a  detailed  discussion  of  these  influences  see  chapters  x  and  xi. 


16  INVESTMENT    ANALYSIS 

cipal  and  income,  it  does  not  necessarily  follow  that  all  securi- 
ties possess  an  equally  ready  marketability.  The  security  of  a 
small  city  may  possess  the  highest  degree  of  safety,  but  its  nar- 
row and  inactive  market  might  make  it  difficult  to  sell  if  an 
immediate  sale  were  imperative.  A  forced  sale  would  probably 
mean  a  sacrifice  in  the  sale  price.  But,  if  ready  convertibility 
is  demanded,  it  must  be  paid  for  in  a  lower  rate  of  return  than 
can  otherwise  be  procured  in  a  security  of  equal  value  which 
tloes  not  have  an  immediate  convertibility.  An  investor,  how- 
ever, purchases  a  security  for  holding,  and  he  has,  with  few 
exceptions,  no  need  of  ready  convertibility.  At  most,  the 
investor  will  need  only  a  fraction  of  his  holdings  in  immediately 
convertible  securities,  to  meet  an  emergency.  A  great  deal 
has  been  sacrificed  by  American  investors  who  have  paid  for 
ready  marketability,  when  it  served  them  no  purpose.  Euro- 
pean investors  are  not  so  often  guilty  of  purchasing  something 
they  do  not  need.  They  are  mindful  of  the  fact  that  they  are 
purchasing  to  retain  the  security  until  maturity.  The  safety 
of  their  principal  is  equally  good,  and  the  slower  market  is 
compensated  for  by  a  higher  rate  of  return.  Though  less  fre- 
quently considered  by  the  average  layman,  the  question  whether 
it  is  essential  that  income  be  sacrificed  for  convertibility  should 
be  given  more  consideration. 

A  great  many  corporations,  for  purposes  of  emergency,  must 
keep  a  certain  amount  of  funds  in  such  form  that  they  can 
readily  be  converted  into  cash.  In  these  cases,  convertibility  is 
essential,  as  a  corporation  may  unexpectedly  be  forced  to  call 
upon  all  its  available  resources.  At  the  time  of  a  crisis  it 
would  be  costly  for  a  corporation  to  have  securities  that  could 
not  be  immediately  disposed  of  without  a  large  sacrifice. 

The  character  and  size  of  a  company  will  largely  determine 
the  breadth  and  activity  of  its  market.  If  the  earnings  of  the 
company  have  a  wide  and  irregular  fluctuation,  ready  converti- 
bility may  be  obtained  and  a  higher  rate  of  income  procured, 
but  at  a  sacrifice  of  the  principal.  The  same  would  also  be  true 
of  a  purely  speculative  issue.  But  as  the  conversion  of  secu- 
rity holdings  is  most  frequently  needed  during  a  falling  or 
depressed  security  market,  the  risk  involved  in  a  speculative- 


PRINCIPLES  OF  INVESTMENTS  17 

investment  would  offset  the  advantages  of  conversion.  Equally 
dangerous  would  it  be  for  the  corporation's  surplus,  if  its  sur- 
plus were  invested  in  a  high  class  security  that  had  an  active 
but  narrow  market,  for  the  narrowness  of  the  market  usually 
increases  under  the  strain  of  a  general  market  depression.  The 
market  of  a  security  for  a  business  surplus  must  possess  con- 
tinued strength  as  well  as  activity. 

Legality. — In  addition  to  the  dependence  of  the  value  of  a 
security  upon  the  market  and  the  internal  condition  of  the  pri- 
vate or  civil  corporation,  there  is  the  third  factor  of  legality. 
Legality  of  securities  becomes  basic  to  security  values  when  the 
rights  and  limitations  of  these  securities  are  defined  by  consti- 
tutions and  statutes,  and  interpreted  by  courts  and  commissions. 
Questions  affecting  legality  of  stock  issues  and  their  rights  have 
been  so  well  standardized  that  the  question  of  direct  priorities 
and  claims  is  of  rare  occurrence.  Disputed  claims  are  more  apt 
to  occur  concerning  the  mortgages  back  of  bond  issues ;  namely, 
counter  claims  between  the  creditors  of  the  corporation.  The 
standardization  and  the  extraordinary  care  taken  by  the  high 
grade  banking  house  in  the  selection  of  legal  counsel,  have  made 
the  question  of  legality,  the  most  important  to  the  investor,  the 
least  to  be  feared.  When  a  legal  question  has  once  been  cor- 
rectly interpreted,  unlike  either  market  or  internal  factors 
affecting  security  values,  it  is  fixed  as  long  as  the  statute  in  ques- 
tion is  in  force.  Other  factors  affecting  security  values  never 
remain  constant.  They  are  constantly  changing,  a  condition 
which  necessitates  a  constant  and  intelligent  watching  of  mar- 
ket and  corporate  conditions. 

As  long  as  the  corporation  is  meeting  all  of  its  obligations, 
no  attention  is  paid  to  priorities  or  claims  of  holdings.  Let 
the  corporation,  however,  get  into  difficulties  that  may  or  do 
bring  about  receivership,  and  legality  then  does  become  of  first 
concern  to  the  holder  of  the  security.  Where  the  organization 
is  large,  and  is  composed  of  many  subsidiary  corporations,  as 
are  most  railroads,  many  counter  claims  of  creditors  are  apt 
to  arise.  If  out  of  the  tangle  of  mechanics  liens,  underlying 
issues  upon  particular  properties  or  readjustments,  issues  fol- 
lowing several  junior  issues,  etc.,  the  properties  are  adequate  to 


18  INVESTMENT    ANALYSIS 

cover  the  security  holder's  claims,  his  legal  rights  can  be  said 
to  be  worth  par.  It  is  legality  in  this  sense  which  concerns  the 
investor. 

In  civil  loans  legality  is  quite  distinct  from  the  problem  of 
legality  in  corporate  loans.  Specific  claims  in  the  form  of  mort- 
gages supporting  the  creditors  usually  do  not  exist  in  civil 
loans,  except  in  a  few  instances1  where  specific  rights  against 
the  property  are  given  by  the  municipality.  The  security  of 
the  creditor's  claim  depends  wholly  upon  the  civil  divisions' 
powers  and  rights  to  levy  and  collect  taxes.  As  a  result,  an 
illegal  or  void  issue  does  not  have  a  single  dollar  of  tangible 
property  to  satisfy  its  claim.  The  careful  distinction  which  is 
now  made  in  statutes  between  principal  and  interest  should 
also  warn  the  investor  that  the  legality  of  the  one  might  be 
maintained  without  the  other.  A  certain  civil  division  in  the 
southern  states,  on  whose  issue  the  interest  has  been  legally 
declared  without  claim,  is  only  awaiting  the  date  of  maturity 
to  pay  its  principal.  But  an  issue  of  civil  securities  in  these 
days  is  rarely  illegally  issued,  though  the  purchaser  of  these 
securities  must  remember  that  an  illegal  issue  will  have  no 
recourse  to  tangible  assets  of  any  character.  Even  the  innocent 
purchaser,  where  the  issue  is  made  without  legal  authority,  must 
accept  his  losses. 

The  legality  of  the  bond  should  not  be  confused  with  what 
constitute  particular  claims  of  an  issue.  An  investor  frequently 
assumes  from  the  name  of  the  issue  that  he  possesses  certain 
priorities  in  claims  which  the  description  of  the  mortgage 
clearly  does  not  indicate.  A  careful  reading  of  the  mortgage 
deed,  or  even  the  statements  on  the  bond  certificate  itself,  would 
reveal  very  specifically  what  these  claims  constitute.  But  the 
loss  that  the  investor  might  suffer  in  insolvency  and  receiver- 
ship because  of  his  claims  being  further  removed  than  he 
thought,  is  not  an  error  of  legality,  but  a  loss  due  to  careless- 
ness on  the  part  of  the  investor  as  to  an  understanding  of  what 
his  claims  are.  So  frequently  have  investors  suffered  losses 


JThe  more  common  of  these  liens  are  on  water-works  plants,  though 
one  issue  of  school  district  bonds  is  recalled  in  which  a  mortgage  was 
placed  on  the  school  house  as  security. 


PRINCIPLES  OF  INVESTMENTS  19 

because  of  this  confusion,  that  the  actual  rights  of  the  investor 
should  be  ascertained  by  a  careful  reading  of  the  mortgage 
instrument,  or  by  a  detailed  interrogation  of  the  banker  selling 
the  issue. 

Neither  should  the  certification  which  vouches  for  the  gen- 
uineness of  an  issue  be  confused  with  the  validity  of  the  secu- 
rity. The  former  pertains  to  the  right  of  issue,  the  latter  to 
correctness  of  the  issue.  Law  firms  skilled  in  municipal  law 
usually  pass  upon  the  accuracy  of  the  issue  and  trust  companies 
certify  as  to  the  genuineness  without  affirming  the  validity  of 
the  issue.  Investors  of  municipals  knowing  the  necessity  of 
legal  accuracy,  should  refuse  to  purchase  an  issue  whose  validity 
has  not  had  the  certified  approval  of  a  well-known  legal  firm 
specializing  in  municipal  law.  And  it  is  upon  the  character  of 
the  legal  firm  that  the  analyst  must  base  his  conclusion. 

Stability  of  Market  Price. — Stability  of  market  price  is  often 
confused  with  safety  of  principal.    Where  the  safety  of  the 
principal  is  assured,  the  fluctuations  in  the  market  price  are 
generally  caused  by  a  change  in   general  market  conditions. 
George  G.  Henry  interprets  these  price  movements  as  follows: 
"Broadly  speaking,  the  market  movements  of  all  negotiable 
securities  are  controlled  by  two  influences,  sometimes  acting  in 
opposition  to  each  other  and  sometimes  in  concert.    One  of 
these  influences  is  the  loaning  rate  of  free  capital ;  the  other  is 
the  general  condition  of  business.     A  low  rate  of  interest  or  the 
likelihood  of  low  rates  has  the  effect  of  stimulating  security 
prices,  because  banks  and  other  money-lending  institutions  are 
forced    into   the   investment   market   when   they   cannot   loan 
money  to  advantage.     Conversely,  a  high  rate  of  interest  or  the 
prospect  of  high  rates  has  the  effect  of  depressing  prices,  because 
banking  institutions  sell  their  securities  in  order  to  lend  the 
money  so  released.    The  automatic  working  of  this  process  tends 
to  produce  a  constant  adjustment  between  the  yields  upon  free 
and  invested  capital.     When  money  rates  are  low,  securities 
tend  to  advance  to  the  point  where  the  return  upon  them  is  no 
greater  than  that  derived  from  the  loaning  of  free  capital.  When 
rates  are  high,  securities  tend  to  decline  to  a  point  where  the  re- 
turn is  as  great.    This  explains  the  influence  of  the  first  factor. 


20  INVESTMENT    ANALYSIS 

' '  The  other  factor  is  the  general  condition  of  business.  Good 
business  conditions,  or  the  promise  of  good  conditions,  tend  to 
advance  security  prices,  because  they  indicate  larger  earnings 
and  a  stronger  financial  condition.  Poor  business  conditions,  or 
an  unpromising  outlook,  have  the  reverse  effect. 

"The  larger  movements  of  security  prices  are  always  the 
resultant  of  the  interaction  of  these  two  forces.  When  they 
work  together  the  effect  is  irresistible,  as  when  low  interest  rates 
and  the  prospect  of  good  business  conditions  occur  together,  or 
when  high  money  rates  occur  in  the  face  of  an  indicated  falling 
off  in  business  activity.  At  such  times  all  classes  of  securities 
swing  together. ' '  * 

In  periods  of  business  depressions  or  financial  panics,  safety 
of  principal  is  affected;  but  the  more  stable  a  security,  the  less 
is  its  market  price  affected  by  changing  market  conditions. 
These  factors,  however,  affect  a  stable  security  only  temporarily. 
Yet  there  are  influences  which,  other  things  being  equal,  may 
result  in  a  permanent  lowering  or  raising  of  the  security  price. 
A  general  fall  in  prices  may  be  caused  by  a  large  demand  for 
capital  and  a  corresponding  rise  in  interest  rates,  or  by  an  over- 
supply  of  the  securities  due  to  the  decrease  in  demand  or  a 
growing  scarcity  in  the  commodity  used.  Under  reverse  con- 
ditions, prices  will  rise.2  These  influences  are  external,  and 
while  they  may  affect  the  price  of  the  security,  they  must  not 
be  confused  with  such  causes,  as  arise  out  of  a  company's  own 
internal  condition.  Any  considerable  fluctuation  in  price 
resulting  from  this  latter  source  must  be  viewed  with  appre- 
hension. 

Appreciation. — Is  future  appreciation  possible,  if  the 
required  safety  of  principal  and  income  is  assured  at  the  time 
the  investment  is  made?  If  appreciation  should  arise  out  of  a 
change  in  the  attitude  of  the  market  or  estimates  of  the  com- 
pany's security,  the  investor  is  the  gainer  thereby,  but  this 
rise  is  the  result,  not  of  any  change  in  the  value  of  the  security, 
but  of  a  change  from  a  former  mistaken  judgment  which  under- 

'George  G.  Henry,  How  to  Invest  Moneif  (190S),  pp.  109-111.     Also 
see  chapters  x  and  xi  on  "Market  Influences  on  Security  Prices." 
'See  chapter  xi  on  "Market  Influences  on  Security  Prices." 


PRINCIPLES  OF  INVESTMENTS  21 

estimated  the  value  of  the  security.  A  change  in  the  attitude 
of  the  market  in  this  case  causes  a  change  in  demand,  but  does 
not  affect  the  safety  of  the  security.  If  appreciation  arises  out 
of  any  change  within  the  company,  which  is  true  appreciation, 
it  must  have  some  direct  effect  on  the  other  factors  of  the  ideal 
investment.  Where  appreciation  occurs,  the  safety  of  principal 
and  income  will  be  increased  or  appreciation  has  no  significance. 
This  at  once  raises  the  question  as  to  whether  investing  on  the 
possibility  of  appreciation  does  not  make  the  security  a  specu- 
lative risk.  This  obviously  depends  on  where  the  line  of 
demarcation  is  drawn. 

When  safety  and  stability  are  the  chief  considerations,  it  is 
doubtful  whether  the  investor  is  warranted  in  looking  for  much 
appreciation  in  a  security.  The  possibility  of  an  appreciation 
in  price  involves  the  greatest  risk,  and  usually  means  more  than 
a  corresponding  sacrifice  of  the  other  ideal  elements  of  an 
investment. 

A  junior  railroad  bond  or  a  bank  stock  may,  under  rare  con- 
ditions, have  sufficient  security  to  satisfy  all  claims  for  safety, 
and  at  the  same  time  have  large  possibilities  of  appreciation.  It 
is  a  question,  however,  whether  even  in  these  exceptional  cases 
the  safety  of  principal  and  income  are  not  materially  affected  or 
the  amount  of  the  income  legitimately  expected  on  the  invest- 
ment foregone.  The  latter  is  especially  true  of  the  stocks  of  a 
new  bank  which  is  conservatively  managed,  when  small  divi- 
dends are  paid  in  ratio  to  the  amount  added  to  surplus.  But  it 
can  be  argued  that  this  is  merely  a  transferring  of  an  amount 
due  the  stockholder,  to  the  surplus  fund,  and  is  really  the  same 
as  so  much  additional  investment.  This  latter  is  often  inter- 
preted as  appreciation,  though  it  is  not  appreciation  as  the 
term  is  used  here.  If  the  appreciation  in  price  is  relatively 
more  than  the  ratio  of  the  amount  diverted  from  earnings  into 
surplus,  appreciation  can  strictly  be  said  to  have  taken  place. 
It  is,  however,  only  the  investor  with  large  holdings  who  can 
afford  to  wait  for  this  appreciation. 

Occasionally,  because  of  external  conditions,  the  price  of  a 
security  may  suffer  a  temporary  depression  which  is  unwar- 
ranted. Security  prices  affected  by  these  conditions  will  even- 


22  INVESTMENT   ANALYSIS 

tually  appreciate  to  their  true  value.  Louis  Heft,  in  discussing 
the  market  values  of  railroad  bonds  and  notes,  gives  a  clear 
statement  of  these  influences:  "The  market  value  of  a  railroad 
security  does  not  depend  always  upon  its  actual,  intrinsic  value 
alone,  i.e.,  upon  the  property  and  its  foreclosure  value,  pledged 
as  security,  and  the  other  liens,  prior  and  junior,  against  such 
property;  but  it  is  affected  quite  often  and  sometimes  quite 
materially,  by  extraneous  influences,  among  them  the  temper  of 
the  times ;  the  state  of  the  money  market ;  the  quoted  price ; 
whether  or  not  it  has  a  broad  and  ready  market  and  is  a  legal 
investment  for  trust  funds  or  savings  banks;  its  form,  whether 
easy  of  negotiation  and  how  quickly  it  can  be  converted  into 
cash;  when  it  matures;  its  rate  of  interest  and  the  income  it 
produces  at  the  price;  whether  or  not  it  is  listed  on  the  stock 
exchange ;  the  personnel  of  the  board  of  directors  of  the  railroad 
company;  the  prevalent  reports,  true  or  false,  of  the  state  of 
the  finances  and  affairs  of  the  road ;  the  effect  of  recent  legisla- 
tion or  expected  legislation;  recent  decisions  of  the  higher 
courts;  pending  litigation  that  affects  the  road;  events  and 
reports  of  political  significance,  local,  state,  national,  or  inter- 
national. ' ' 

Neither  should  appreciation  be  confused  with  the  fact  that 
the  bond  bought  at  a  premium  or  discount  is  paid  for  at  par,  on 
maturity.  A  bond  bought  on  the  basis  of  95  and  retired  at  100 
has  not  appreciated  5  points.  To  the  purchaser  of  this  bond, 
95  is  the  principal,  and  while  100  is  received  at  maturity,  the 
5  points  have  already  been  allowed  in  the  increase  of  the  net 
yield,  and  only  95  can  be  considered  the  unimpaired  principal 
of  the  investment. 

Further,  an  increase  in  price,  due  either  to  a  change  in  the 
amount  of  money  in  circulation,  or  in  the  demand  for  capital, 
is  also  wrongly  called  appreciation  of  the  security  itself.  The 
price  of  the  security  has  increased,  not  because  of  some  change 
within  the  company  itself,  but  entirely  on  account  of  external 
conditions. 

Diversification. — Though  diversification  is  not  an  inherent 


'Louis  Heft,  Holders  of  Railroad  Bonds  and  Notes,  Their  Rights 
and  Remedies  (1916),  p.  1-2. 


PRINCIPLES  OF  INVESTMENTS  23 

quality  of  the  investment  itself  it  insures  greater  safety  to  the 
total  holdings  of  the  investor.  It  has  long  been  an  accepted 
principle  of  investment  bankers,  that  a  distribution  of  pur- 
chases, regardless  of  how  small  the  total  holdings  may  be,  is  as 
important  as  a  wise  selection  of  the  individual  security.  Abso- 
lute and  unqualified  safety  can  never  be  indefinitely  guaranteed, 
no  matter  how  impregnable  the  position  of  the  security  may 
be  at  the  time  of  its  purchase.  Though  a  very  well  selected 
security  seldom  succumbs  to  failure,  risks — which  can  never 
be  entirely  eliminated — should  be  reduced  to  a  minimum.  The 
danger  of  new  and  unfavorable  risks  is  also  the  reason  why 
changes  in  investments  should  be  made  by  the  holder  if  the 
security  held  begins  to  show  signs  of  permanent  weakness. 

This  risk  can  be  partially  offset  by  a  diversification  of  invest- 
ments, so  that  the  investor's  total  holdings  would  not  be  lost  in 
the  failure  of  one  issue.  It  is  highly  improbable,  with  a  distri- 
bution in  a  widely  scattered  group  of  securities,  that  the  failure 
of  one  issue  would  involve  the  integrity  of  the  other  securities 
held  by  the  investor.  In  order  to  insure  against  such  a  con- 
tingency, a  diversification  of  holdings  should  be  made  in  more 
than  one  type  of  industry.  Legislative  regulation  in  states, 
where  regulation  is  in  its  infancy,  will  probably  be  more  effec- 
tive in  its  influence  on  public  utilities,  than  it  will  be  on  indus- 
trials. And  the  danger  of  repudiation  for  illegality  of  issue, 
though  now  reduced  to  a  minimum,  is  more  possible  in  civil 
loans  than  in  any  other  type  of  securities.  By  a  proper  distri- 
bution, the  advantages  possessed  by  one  security  are  thus  pitted 
against  the  disadvantages  of  another. 

Several  English  writers  strongly  maintain  not  only  that  a 
distribution  of  securities  should  be  made  on  the  basis  of  hold- 
ings in  different  companies,  but  that  it  should  also  follow  along 
the  lines  of  geographical  diversification.  The  contention  -is 
that  as  great  a  reduction  of  risk  is  secured  in  a  geographical 
distribution  as  in  a  distribution  among  different  types  of  com- 
panies.1 While  the  data  are  not  sufficient  to  allow  any  positive 


'See  H.  Lowenfeld.  All  About  Investments  and  Investments  and  Ex- 
act Science.  (The  major  thesis^of  both  of  these  books  is  based  upon  the 
distribution  of  securities. 


24  INVESTMENT    ANALYSIS 

conclusions,  the  experience  of  the  last  European  War  would 
present  a  very  strong  argument  in  favor  of  this  contention. 
This,  however,  would  apply  more  particularly  to  Europe,  as  all 
the  European  countries  are  small  in  geographical  area,  and  any 
serious  disturbance  in  one  country  is  more  likely  to  affect  a  con- 
siderable part  of  the  continent.  On  the  other  hand,  the  United 
States  covers  such  a  large  area  that  geographical  distribution 
is  partially  met  within  its  borders. 

Though  geographical  distribution  does  have  some  very 
decided  arguments  in  its  favor,  it  also  has,  with  the  exception 
of  the  national  loans  of  certain  first  class  countries,  very  posi- 
tive drawbacks.  An  investor  in  the  United  States  having  hold- 
ings in  South  Africa,  Australia,  South  America,  etc.,  finds  it 
difficult  and  often  impossible  to  obtain  detailed  information 
concerning  them.  The  eventual  establishment  of  American 
banks  in  these  countries,  which  has  already  started,  will 
greatly  facilitate  overcoming  the  difficulties  in  securing  first 
hand  information  in  foreign  countries.  But  for  the  present,  at 
least  as  applied  to  the  investor  in  the  United  States,  the  advan- 
tages of  geographical  distribution  of  investments  have  been 
greatly  over-emphasized  by  this  group  of  European  writers. 

The  diversification  obtained  by  selecting  bonds  whose  inter- 
est is  due  in  different  months,  now  frequently  urged  in  adver- 
tisements, must  not  be  confused  with  diversification  which 
effects  greater  safety.  There  is  an  unquestioned  advantage  to 
a  considerable  group  of  investors  in  having  a  regular  income, 
but  this  is  a  convenience  to  the  investor  and  not  a  problem  of 
investment  safety.  The  argument  for  selecting  bonds  falling 
due  in  different  years  is  that  this  practice  results  in  an  elimina- 
tion of  risk  especially  upon  net  yield.  If  all  one's  bonds  came 
due  within  two  years,  the  general  market  conditions  might  be 
such  as  to  make  it  an  inopportune  time  to  invest  all  of  one's 
funds.  Corporations,  likewise,  might  find  it  difficult  to  meet 
maturing  obligations,  under  a  strained  market. 

Other  Criteria  of  Investments. — In  much  of  the  popular 
writing  and  discussion  on  investments,  many  other  criteria  are 
either  substituted  for  the  fundamentals  enumerated  above,  or 
added  to  this  list.  Only  two  or  three  of  these  can  be  referred 


PRINCIPLES  OF  INVESTMENTS  25 

to — a  sufficient  number  to  serve  for  illustration.  Concerning  a 
few  of  these  so-called  fundamentals,  there  are,  no  doubt,  honest 
differences  of  opinion.  But  the  majority  of  them  are  not  prin- 
ciples, but  tests  in  the  application  of  the  principles.  Others 
represent  merely  the  acceptance  of  the  practices  of  existing 
institutions,  such  as  savings  banks  and  life  insurance  companies. 
These  latter  should  be  subjected  to  as  critical  an  analysis  as  the 
investment  itself. 

In  general,  the  fact  that  a  security  is  a  legal  investment  for 
a  savings  bank  of  certain  states  indicates  that  it  is  a  safe 
investment.  This,  however,  is  not  true  of  all  states.  The  stat- 
utes of  certain  states  are  either  so  loosely  framed  that  unwar- 
ranted latitude  is  allowed  in  the  selection  of  securities,  or  the 
state  banking  superintendent  is  given  an  extensive  power  of 
selection.  If  he  is  of  a  speculative  turn  of  mind,  securities  will 
be  found  in  his  list  that  have  no  place  in  the  investments  of  a 
savings  bank.  On  the  other  hand,  a  considerable  correspond- 
ence by  the  author  with  state  savings  bank  examiners  and  super- 
intendents, has  revealed  the  rejection  of  some  of  the  very 
strongest  securities.  In  some  cases  this  was  not  the  fault  of 
the  official,  but  of  a  badly  framed  law.  Any  general  accept- 
ance of  this  criterion  is  wholly  misleading  unless  the  investor 
has  a  knowledge  of  the  statutes  of  the  particular  state  in 
question. 

A  company  whose  bonds  have  complied  with  the  law  for  a 
number  of  years  may  be  forced  into  a  period  of  debility.  The 
company,  in  order  to  maintain  its  previous  credit  position,  will 
sacrifice  the  maintenance  of  its  physical  properties  so  that  its 
securities  may  continue  as  legal  savings.  This  policy  has  too 
frequently  led  to  fatal  consequences.  The  Boston  and  Maine 
Railroad,  with  its  receivership  entanglements,  is  an  interesting 
illustration.  There  are  also  on  the  market  a  number  of  securi- 
ties which  cannot  comply  in  some  slight  detail  with  the  savings 
bank  requirements  for  a  legal  investment.  Nevertheless,  some 
of  these  securities  are  fundamentally  as  sound  as  some  of  the 
securities  listed  as  meeting  the  savings  bank  law.  It  should  be 
noted  that  this  statement  is  not  intended  to  convey  the  idea 
that  all  securities  meet  this  requirement.  Neither  does  a  par- 


26  INVESTMENT   ANALYSIS 

ticular  listed  savings  bank  security  necessarily  meet  all  of  the 
needs  of  the  individual  purchaser.  But  legal  investments  for 
savings  banks,  as  well  as  those  of  insurance  companies  of  some 
states,  are  supposed  to  represent  the  highest  degree  of  safety 
and  avoidance  of  speculative  risks;  consequently,  the  statutes 
and  the  published  legal  investment  lists,  as,  for  example,  of 
Connecticut,  New  York,  and  Massachusetts,  should  be  given 
the  most  careful  attention.1 

The  laws  governing  investments  of  trustees  and  estates  are 
less  uniform  than  those  affecting  the  investments  of  savings 
banks.  The  regulations  are  frequently  so  vague  in  character 
that  there  is  a  constant  temptation  on  the  part  of  the  officials  to 
sacrifice  safety  to  secure  larger  returns.  Often,  courts  them- 
selves, because  of  their  ignorance  of  investment  values,  have 
violated  the  interests  of  estates.  A  great  many  estates  have 
suffered  large  losses  where  they  have  accepted  tax  exempt  securi- 
ties without  regard  to  the  safety  of  the  security.  Further, 
where  the  highest  court  has  not  determined  either  the  limita- 
tions of  the  statutes,  or  what  securities  can  be  specifically 
invested  in,  estate  investments  are  of  little  worth  as  guides. 
And  where  the  trustee  is  given  wide  latitude  the  investment 
made  becomes  a  matter  of  individual  judgment,  and  can  only 
be  valued  as  such.  This  is  largely  true  of  trusteeship  invest- 
ments, for  though  the  court  may  require  a  strict  account  of  the 
whole  trusteeship  against  reasonable  losses,  it  does  not  do  so 
for  any  particular  investment. 

The  so-called  "American  Procedure"  law,  which  practically 
gives  to  the  trustee  (supposedly  an  expert)  discretionary 
powers  of  selection,  holds  true,  with  a  few  modifications,  in 
California,  Delaware,  Illinois,  Maine,  Massachusetts,  Michigan, 
Mississippi,  Montana,  North  Carolina,  Rhode  Island,  South 
Carolina,  South  Dakota,  Texas,  Vermont,  Virginia,  and  Wash- 


JA  very  convenient  form  of  reference  is  Montgomery  Rollins  on 
Laivs  Regulating  the  Investment  of  Bank  Funds,  as  it  is  in  loose  leaf 
form  and  can  be  kept  permanently  revised  at  a  nominal  fee  (original 
issue  1909).  Where  the  acceptable  legal  lists  are  published  by  the 
banking  department,  they,  of  course,  can  be  as  readily  checked  as  any 
other  security. 


PRINCIPLES  OF  INVESTMENTS  27 

ington.  Fourteen  states  can  be  said  to  have  no  regulation. 
Alabama,  Colorado,  Iowa,  and  West  Virginia  approve  only  of 
civil  loans.  Wisconsin,  in  addition  to  civil  loans,  permits 
railroad  bonds  and  real  estate  mortgages  that  have  paid  their 
interest  for  ten  years.  Connecticut  allows  only  savings  banks 
investments,  and  holds  the  trustee  for  losses.  Kentucky  allows 
mortgages,  stocks,  and  bonds,  under  stated  conditions.  Florida 
includes  bank  stocks,  in  addition  to  civil  loans,  and  Pennsyl- 
vania, real  estate  mortgages.  In  Georgia,  Maryland,  Ohio,  and 
Tennessee,  a  special  order  from  the  court  must  be  obtained  before 
investments  can  be  made  in  other  than  state  or  federal  securities. 
In  Minnesota,  the  trustee  must  receive  a  court  order  for  all 
investments/  These  illustrations  fully  bear  out  the  contention 
that  uniformity  does  not  exist,  and  that  only  a  few  states  offer 
any  guidance  to  the  average  investor. 

Investments  of  the  life  insurance  companies  of  New  York 
offer  the  best  opportunity  for  a  study  of  investments  of  this  type 
of  financial  institutions.  In  most  states  insurance  companies  are 
privileged  to  hold  stocks  as  well  as  real  estate  mortgages  and 
bonds.  The  trend  of  the  character  of  investments  of  these  com- 
panies is  an  interesting  chapter  in  the  history  of  investment 
securities.  Up  to  1906  the  trend  was  toward  a  substantial 
decrease  in  the  proportion  of  mortgages  to  stocks  and  bonds, 
but  since  that  period  the  tendency  has  been  in  the  opposite 
direction.2  The  companies  of  the  Middle  West  have  always 
held  a  larger  proportion  of  mortgages  than  eastern  companies 
and  have  consequently  shown  a  larger  rate  of  return  on  their 
investments.  With  the  future  adjustment  under  the  Federal 
system  of  land  mortgage  banks,  together  with  the  closer  settle- 
ment of  farm  areas,  this  advantage  will  not  always  continue. 


'See  August  P.  Loring,  Trustees  Handbook.  This  will  be  found  sug- 
gestive to  the  lay  reader,  though  it  is  now  out  of  date,  as  the  laws 
affecting  trustees  are  constantly  changing. 

2See  Lester  Zartman.  The  Investments  of  Life  Insurance  Companies 
(1907)  ;  also  R.  L.  Cox  (pamphlet  issued  by  Life  Insurance  Presidents' 
Association.  1915),  Geographical  Distribution  of  Life  Insurance  Invest- 
ments; George  T.  Wight,  Life  Insurance,  Farm  Loan  Investments  in 
War  Time  (pamphlet  issued  by  Life  Insurance  Presidents'  Association, 
1918) . 


28  INVESTMENT    ANALYSIS 

Whether  these  normal  trends  of  life  insurance  companies  can 
be  considered  a  guide  for  the  private  investor  and  his  particular 
needs  is,  of  course,  open  to  question. 

The  securities  held  by  state  banks  (commercial)  as  a  class 
cannot  be  accepted  as  an  absolutely  good  criterion.  The  varia- 
tion in  the  laws  authorizing  both  the  existence  of  state  banks 
and  the  subsequent  control  is  too  great  to  insure  that  state  banks 
will  all  serve  equally  well  as  guides  in  passing  on  corporate 
affairs.  The  purpose  for  which  national,  as  well  as  state  banks, 
are  created,  is  to  do  a  commercial  banking  business.  If  they  have 
the  same  security  demanded  by  individual  purchasers,  in  their 
holdings,  very  much  more  highly  convertible  investments  must 
be  had  to  insure  the  liquidity  needed  in  their  investments.  It 
is  questionable,  then,  whether  (except  for  business  surpluses  or 
where  there  may  be  a  demand  for  hurried  liquidation)  com- 
mercial bank  holdings,  as  a  class,  are  suited  as  a  criterion  for 
individuals  who  demand  more  permanent  holdings. 

It  is  too  common  a  belief  that  listing  a  security  in  some  sort 
of  way  guarantees  the  security.  This,  no  doubt,  grows  out  of 
the  much  discussed  establishment  of  a  wide  and  free  market 
where  speculation  is  allowed  to  have  free  sway.  This  is  a 
confused  idea.  If  a  small  issue  is  listed  and  the  securities  are 
purchased  at  irregular  intervals,  its  market  may  not  be  as  active 
as  the  market  created  by  a  strong  banking  house  for  its  own 
issues.  Though  the  common  market  secured  in  listing  on  the 
exchange  furnishes  a  more  ready  market  during  periods  of 
depression,  there  is  no  guarantee  that  the  less  active  and  smaller 
listed  issues  will  find  immediate  sale.  However,  it  must  be 
recognized  that  the  large  and  active  securities  listed  on  the 
stock  exchange  do  have  the  most  immediate  market. 

An  advantage  is  also  supposed  to  exist  because  of  certain 
information  given  to  the  listing  committee  of  the  exchange,  and 
because  of  the  certification  by  a  trust  company  that  the  securi- 
ties are  authoritatively  issued  by  the  corporation  named  on  the 
application.  While  this  practice,  no  doubt,  has  greatly  tended 
to  encourage  the  publishing  of  more  complete  information  con- 
cerning corporate  affairs,  this  information  is  extremely  limited 
as  compared  to  what  the  banker  underwriting  a  security  must 


PRINCIPLES  OF  INVESTMENTS  29 

have.  The  exchange  is  merely  an  institution  that  furnishes  a 
market  place  and  fixes  the  fees  that  may  be  charged  by  its 
members  to  their  clientele.  The  regular  reports  submitted  are 
largely  for  the  purpose  of  having  evidence  that  the  corporation 
is  legitimately  operated.  No  personal  examination  or  investiga- 
tion is  made  by  the  officers  of  the  exchange.  They  do  not  in 
any  way  vouch  for  the  company,  nor  are  the  data  required  by 
them  in  any  way  adequate  for  the  purposes  of  making  a  com- 
plete analysis  of  the  corporation.  As  long  as  the  corporation  is 
a  genuine  institution,  and  conducting  a  legitimate  business,  the 
listing  committee  allows  the  corporation  to  have  its  securities 
sold  upon  the  exchange  market.  But  this  is  an  entirely  differ- 
ent thing  from  stating  that  the  security  purchased  upon  the 
exchange  is  of  a  certain  value.  The  investment  banker  must 
have  such  information  or  he  cannot  continue  business.  On  the 
other  hand,  a  voluntary  association  of  the  character  of  the 
stock  exchange  would  defeat  its  real  purpose  if  it  attempted 
to  do  more  than  vouch  for  the  genuineness  of  the  corporate 
securities.  To  guarantee  the  genuineness  of  the  certificates, 
however,  is  quite  different  from  guaranteeing  the  value  of  the 
security.  Furthermore,  as  far  as  genuineness  of  the  certificate 
is  concerned,  the  great  majority  of  corporation  bonds  today  are 
certified  by  a  trustee  whether  they  are  listed  or  not.  This  cau- 
tion does  not,  however,  overlook  the  fact  that  the  New  York 
Stock  Exchange  does  have  the  power  of  holding  its  members 
to  rigid  account  for  honest  dealing,  and  that  it  has  particularly 
exercised  this  power  in  recent  years. 

An  examination  of  the  most  important  stock  exchanges  in 
the  country  shows  that  normally  only  from  20  to  25  per  cent 
of  the  bond  listings  have  a  very  active  market.  And  even  when 
these  issues  are  traded  in,  they  form  a  very  small  proportion 
of  the  total  volume  of  the  stock  exchange  trading  for  the  day. 
Among  the  issues  underwritten  by  bankers  in  the  United  States 
and  never  listed,  there  are  many  with  a  wider  and  freer  market 
than  the  inactive  listed  issues  on  the  stock  exchange.  This  is 
especially  true  of  the  securities  listed  in  exchanges  outside  of 
the  New  York  Stock  Exchange.  The  necessity  of  maintaining  a 
free  market  is  of  such  consequence  to  the  bank  underwriting 


30  INVESTMENT   ANALYSIS 

an  issue  that  it  will  use  every  effort  through  its  own  offices  to 
maintain  this  market. 

Commercial  bankers  in  New  York  who  lend  on  collateral  it 
is  true,  still  give  preference  to  the  active  listed  securities.  But 
even  here  differentiation  must  be  made  between  the  practice 
of  New  York  banks  and  banks  of  the  interior,  where  high  grade 
bonds,  though  not  active,  are  as  readily  accepted  for  collateral 
as  more  active  securities.  The  larger  part  of  the  advances  of 
bankers  in  New  York,  however,  are  on  securities  held  for  specu- 
lation. To  the  investor  who  purchases  securities  and  places 
them  in  a  strong  box,  a  high  degree  of  hypothecation  value  is 
not  the  most  important  consideration,  for  he  would  be  paying 
for  an  advantage  he  does  not  need.  For  the  banker  making 
loans  from  day  to  day,  the  acceptance  of  listed  securities  is  the 
simpler  and  safest  plan,  as  he  can  more  easily  follow  the 
price  movements  of  the  securities  which  he  holds  as  collateral. 
With  this  close  observation  of  prices,  the  general  information 
which  the  "loan  cashier"  obtains  concerning  the  character  of 
the  corporation  has,  according  to  practice,  been  adequate.  In 
these  very  methods  of  advancing  funds  which  give  such  great 
liquidity  to  security  markets,  also  lurks  the  greatest  danger  to 
the  stability  of  the  security  market  in  periods  of  depression. 

In  rapidly  changing  markets  especially,  the  quoted  price  of 
the  less  active  issues  cannot  be  taken  as  an  indication  of  the 
price  that  will  be  paid  for  the  next  offering.  If  the  amount  is 
large,  the  inactive  listed  security  may  find  no  market,  or  the 
price  may  be  greatly  depressed.  And  even  in  securities  of  the 
highest  value  there  is  no  guarantee,  especially  with  stocks,  that  a 
price  has  not  been  pegged — i.e.,  supported  by  a  bank  or  indi- 
viduals— and  the  price  under  heavy  selling  pressure  would  then 
have  that  much  greater  drop.  The  market,  it  is  true,  eventually 
discounts  such  influences,  but  what  of  the  losses  in  the  interim  ? 
This  does  not  signify  that  the  same  danger  does  not  exist  in 
unlisted  securities.  Where  it  does,  and  reactions  occur,  the 
results  are  even  worse.  The  pegged  price  is  generally  a 
thing  to  be  shunned.  Now  and  then  a  large  bank  has  main- 
tained the  price  of  a  new  issue  in  a  company  that  showed 
positive  evidence  of  future  earning  power.  In  the  latter  case 


PEINCIPLES  OF  INVESTMENTS  31 

the  strength,  and  ability  of  the  banking  house  should  be  exam- 
ined as  well  as  the  soundness  of  the  corporation. 

In  distinguishing  between  the  advantages  of  listed  or 
unlisted  securities,  the  purpose  of  the  investment  would,  from 
the  preceding  discussion,  appear  to  be  the  principal  guide  to 
the  investor.  If  the  security  is  purchased  purely  for  invest- 
ment yield  and  to  be  held  till  maturity,  activity  of  the  market 
may  serve  no  purpose.  If  it  is  necessary  to  use  the  securities 
frequently  as  collateral  in  stock  exchange  centers  or  if  the 
investment  is  to  be  used  for  banking  funds,  or  a  corporation's 
surplus,  then  a  listed  issue  often  possesses  a  decided  advantage, 
especially  if  it  is  a  large  and  active  issue.  Again,  for  example, 
there  are  a  large  number  of  corporation  note  issues  which  are 
not  listed  but  which  have  an  active  outside  market  and  which  are 
considered  good  collateral.  From  the  investment  point  of  view, 
the  strict  adherence  to  the  application  of  the  fundamentals  laid 
down  in  chapter  two,  as  applied  to  the  purpose,  is  the  safest 
course.  And  a  proper  understanding  of  investment  values  will 
disclose  where  security  prices  depart  from  their  actual  worth. 


CHAPTEE  III 

WHAT  IS   INCLUDED   UNDER  INVESTMENT   SECURI- 
TIES, AND  THE  CLASSIFICATION  OF  INVEST- 
MENT SECURITIES 

The  needs  of  corporate  and  municipal  financing  have  evolved 
numerous  security  issues  to  provide  funds.  Each  class  of  these 
securities,  whether  counted  as  an  investment  or  not,  serves  a 
particular  demand.  Useful  as  the  function  of  all  these  various 
instruments  of  financing  may  be  to  business,  our  study  is  strictly 
confined  to  investment  securities. 

Bond  classifications,  for  the  most  part,  are  for  the  purpose 
of  designating  common  characteristics  which  will  assist  in 
analysis.  Bonds  and  mortgages,  as  a  class,  are  the  most  ideal 
forms  of  investments,  but  it  does  not  follow  that  all  bonds  and 
mortgages  are  ideal  investments.  Neither  does  it  mean  that 
there  are  no  stocks  which  cannot  be  considered  as  investments. 
There  are  stocks  issues  which  are  far  superior  to  some  bonds 
and  mortgages.  A  statement  of  the  characteristics  of  stocks, 
mortgages,  and  bonds  will  make  this  clearer,  and  also  partly 
explain  why  bonds  and  mortgages,  more  completely  than  any 
other  class  of  securities,  fulfill  the  requirements  of  an  ideal 
investment. 

Stocks  of  a  corporation  represent  ownership  in  the  corpora- 
tion, and  with  it,  the  right  to  determine  its  policy  by  vote 
(usually  only  in  the  case  of  common  stock)  and  to  share  its 
profits.  With  ownership  goes  the  risk  of  proprietorship.  The 
ownership,  for  all  practical  purposes,  represents  a  continuous 
holding,  and  can  be  realized  upon  only  by  liquidation  of  the 
corporation,  or  by  the  sale  of  the  securities.  Even  where  capi- 
tal stock  is  divided  into  common  and  preferred,  and  the  latter 
is  given  preference  to  assets  and  dividends,  this  is  true.  Where 
no  bond  issues  are  outstanding,  and  a  regulation  provides  for 

32 


CLASSIFICATION  OF  SECURITIES  33 

preferred  stock  priority  over  any  subsequent  issues,  the  financial 
position  of  preferred  stock  in  relation  to  common  stock  is  the 
same  as  that  of  a  bond,  though  its  legal  position  is  not.  The 
stockholder  cannot  enforce  the  payment  of  dividends  as  the 
bondholder  can  his  interest. 

The  long  established  and  large  earning  power  of  a  consid- 
erable number  of  industries  issuing  preferred  stock  has  more 
than  offset  these  legal  objections.  Because  of  this  exacting  legal 
qualification,  the  selection  of  preferred  stocks  as  investments 
must  be  more  rigidly  made  and  confined  to  a  much  narrower 
group  of  preferred  stock  issues.  Even  some  of  the  bankers  who 
have  specialized  in  high  grade  preferred  stock  issues  have  not 
adhered  with  the  same  degree  of  faithfulness  to  sound  invest- 
ment principles  as  those  dealing  exclusively  in  higher  grade 
bonds  and  notes.  Since  the  rude  awakening,  however,  experi- 
enced by  the  preferred  stock  market  following  the  over  issue  of 
preferred  stock  from  1907  to  1912,  the  situation  has  been 
improved.  Well-worded  regulations  were  seemingly  accepted 
as  ample  security  for  many  enterprises  which  were  grossly  over- 
capitalized, and  whose  issue  of  stock  was  unwarranted.  The 
depression,  following  the  regular  "temporary  after-panic- 
boom,"  checked  much  of  this  ill-advised  financing  sooner  than 
would  otherwise  have  been  possible.  The  experience  has  not 
been  without  its  profit  to  the  investment  market.  In  the  higher - 
grade  preferred  stock  issues,  the  same  method  of  financial 
analysis  (not  legal)  employed  in  determining  the  security  of  a 
bond,  can  be  used.  The  margins  of  safety,  however,  necessarily 
must  be  larger  than  those  for  bonds,  but  so  far  as  the  analysis 
of  securities  goes — the  principles  laid  down  in  this  book  can 
apply  as  well  to  stocks  as  bonds. 

Credit  loans,  some  of  which  form  our  most  ideal  investments, 
can  be  classed  under  two  general  divisions:  namely,  (1)  current 
accounts,  and  (2)  time  loans.  Under  the  first,  come  all  forms 
of  commercial  and  bank  credit.  Under  the  second,  are  classed : 
promissory  notes,  building  and  loan  association  securities,  some 
forms  of  insurance  policies,  mortgages,  and  bonds.  All  of  the 
second  group  are  based  on  contracts  of  a  formal  character  which 
state  the  amount  of  the  principal,  the  date  of  payment,  the  rate 


34  INVESTMENT    ANALYSIS 

of  interest,  the  payor,  the  payee  and  the  terms  of  the  contract. 
Of  these  securities,  the  promissory  note,  used  for  current  obli- 
gations, is  an  instrument  employed  almost  exclusively  in 
commercial  banking,  to  which  its  study  particularly  belongs. 
Likewise,  the  building  and  loan  association  securities  and  the 
special  investment  forms  of  insurance  are  governed  by  such  spe- 
cial considerations  that  they  are  deserving  of  more  particular 
treatment  than  can  be  given  in  these  pages.  The  closer  kinship, 
however,  of  mortgages  and  bonds,  both  as  to  legal  and  financial 
security,  does  permit  much  the  same  analysis. 

The  mortgage  instrument  is  a  formal  written  contract  in 
which  the  payor,  for  the  use  of  funds  secured  by  his  property, 
usually  real  estate,  agrees  to  pay  interest  and  to  return  the 
amount  of  the  principal  at  a  given  due  date.  The  large  amount 
of  these  loans  held  by  insurance  companies  and  savings  banks  is 
an  evidence  of  the  high  regard  in  which  these  securities  are  held. 
For  certain  classes  of  investors  they  are  not  so  desirable  as 
equally  secured  bonds,  but  discrimination  must  be  made  in 
supplying  needs  of  different  classes  of  investors  if  we  are  to 
follow  sound  investing  to  its  logical  conclusion. 

With  equal  security  mortgages  have  averaged  a  higher  rate 
of  return  on  the  investment  than  bonds.  In  declining  mar- 
kets, where  sales  have  been  forced,  the  fall  in  the  price  of  mort- 
gages has  been  more  pronounced.  The  market  is  always  nar- 
rower and  their  turn-over  slower.  Often  disputed,  as  this  last 
point  is,  the  position  of  the  old  national  banking  law  seems  to 
recognize  the  slowness  of  mortgage  realty  turnover.  The  hypo- 
thecation of  mortgages  (that  is,  the  depositing  of  the  mortgage) 
has  been  equally  disadvantageous  in  depressed  markets.  The 
short  duration  of  the  average  mortgage  in  this  country  also  has 
been  a  serious  objection  of  those  who  have  sought  long  time 
investments  in  order  to  avoid  the  constant  care  of  reinvesting. 
A  mortgage  also  lacks  the  convenience  of  a  small  or  common 
standard  of  denomination,  which  frequently  makes  it  difficult  to 
find  a  buyer  with  the  exact  amount  of  the  mortgage  offered. 
Mortgage  companies  have  overcome  this  objection  by  the  issu- 
ance of  certificates  or  bonds  against  the  mortgage.  This,  of 
course,  then  transfers  the  investment  to  the  class  of  bonds  for 


CLASSIFICATION  OF  SECURITIES  35 

which  a  national  market  is  now  being  rapidly  developed.  The 
numerous  restrictions  in  the  statute  of  limitations  have  also 
made  the  real  estate  mortgage  foreclosure  proceedings  more 
costly  than  bond  foreclosures.  The  larger  amounts  of  the  bond 
issues  and  the  convenience  of  the  trusteeships  greatly  reduce 
these  costs  for  bonds,  and  leave  the  investor,  not  versed  in  the 
intricacies  of  the  law,  free  of  these  difficulties.  This  advantage 
does  not,  of  course,  apply  to  the  real  estate  bond.  Where  the 
mortgage  is  on  local  property,  there  is,  on  the  other  hand,  the 
decided  advantage  of  having  the  property  under  personal 
observation. 

The  bond  is  a  formal  species  of  the  promissory  note.  The 
bond  differs  from  the  ordinary  promissory  note  in  the  greater 
formality  of  the  instrument  and  its  length  of  life.  They  are 
alike,  in  that  they  both  must  be  cancelled  by  payment.  The 
bond,  like  the  note,  is  a  conditional  contract  which  contains  an 
agreement  promising  to  pay  a  fixed  sum  of  money  on  a  specific 
date,  with  a  fixed  rate  of  interest,  paid  at  certain  intervals. 
The  rights,  privileges,  and  limitations  granted  the  holder  of  a 
registered  bond,  as  well  as  the  payor  of  the  obligation,  are 
determined  by  the  kind  of  instrument  issued. 

In  less  than  a  half  century,  the  corporation  bond  has  come 
into  prominence.  Prior  to  this,  bonds  had  been  used  in  Federal, 
state,  and  to  a  limited  extent  in  municipal  financing.  But  even 
the  great  municipal  bond  issuances  are  of  more  recent  years. 
With  the  municipal  bond,  there  have  also  developed  a  large 
number  of  municipal  statutes  and  legal  decisions,  which  are  fur- 
ther evidence  of  its  growing  importance.  Prior  to  the  World 
War,  the  total  annual  corporate  and  municipal  bond  issues  had 
reached  from  one  and  a  half  to  one  and  three  quarters  billions 
of  dollars.  If  the  World  War  teaches  a  national  thrift  one-half 
as  thorough-going  as  the  well-known  French  thrift,  what  a  mar- 
ket has  been  created  for  American  municipal  and  corporate 
bonds ! 

The  wishes  of  all  classes  of  investors  can  be  satisfied  by  a 
selection  from  a  great  variety  of  offerings  ranging  from  a  Fed- 
eral bond,  par  excellence  of  safety,  to  the  bond  which  borders 
on  speculative  risk  with  its  corresponding  higher  rate  of  return. 


36  INVESTMENT    ANALYSIS 

Denominations  range  from  a  $50  Liberty  bond  or  a  $100  rail- 
road bond,  to  the  $10,000  Federal  bond.  Notes  of  short  dura- 
tion, and  bonds  with  a  term  of  a  century  are  to  be  had  with 
marketable  values  corresponding.  In  the  selection  of  a  bond,  a 
preponderance  of  any  one  of  these  elements  may  be  secured. 
As  stated  in  a  previous  chapter,  however,  when  the  purchaser 
demands  any  one  of  these  elements  in  a  greater  degree  than 
needed,  he  suffers  a  corresponding  loss  in  his  net  yield  by  pay- 
ing a  higher  price  for  the  bond. 

A  particular  reference  should  be  made  to  the  place  that 
short-term  notes  having  the  formal  security  of  a  bond  have 
come  to  occupy.  "With  the  increased  use  of  funded  obligations 
on  the  part  of  industrials,  the  short-termed  notes  in  the  next 
decade  will  have  a  larger  importance  than  in  the  past.  In  the 
past,  short-termed  notes  have  been  used  merely  for  emergency 
purposes  or  to  tide  a  corporation  over  a  bad  market  until  inter- 
est rates  had  adjusted  themselves  to  lower  levels.  This  use  of 
notes  particularly  has  been  made  by  corporations  with  larger 
fixed  properties  and  normally  carrying  large  funded  obliga- 
tions. Notes  in  these  companies  have  often  been  used  to  take 
care  of  obligations  assumed  for  extensions,  improvements  or  the 
funding  of  old  obligations. 

While  this  use  of  secured  notes  will  continue,  short-termed 
notes  will  find  larger  use  in  the  permanent  financing  of  certain 
types  of  large  industrials.  This  will  be  true  particularly  of 
industrials  which  can  come  into  the  market  at  irregular  inter- 
vals for  large  supplies  at  advantageous  prices.  With  provi- 
sions for  a  relatively  larger  margin  and  a  generally  more  con- 
servative policy  in  their  issuance  than  required  of  bonds,  notes 
should  be  equally  safe.  Their  purchase,  however,  should  be 
confined  to  large  purchasers  of  securities  in  very  close  touch 
with  the  market  or  buyers  who  need  to  liquidate  their  funds 
within  a  particularly  short  time.  There  seems  to  be  little  to 
argue  in  their  favor  for  the  investor  who  should  put  his  funds 
in  long-time  obligations.  There  may  be  exceptions  when  the 
investor  desires  to  wait  for  a  more  advantageous  market,  though 
note  issues  are  not  normally  put  out  at  these  times  because  of 
the  disadvantage  to  the  corporation. 


CLASSIFICATION  OF  SECURITIES  37 

Classification  of  Bonds. — The  direct  mortgage,  because  of  its 
simplicity,  seems  hardly  to  call  for  a  classification,  except  where 
it  is  a  part  of  a  bond  issue.  The  great  number  of  individual 
types  of  bonds,  of  which  there  are  now  several  hundred,  necessi- 
tate a  reduction  to  some  simple  classification  in  order  that  the 
discussion  may  proceed  in  an  orderly  and  scientific  manner. 
The  large  number  of  names  and  qualifications  which  may  be 
attached  to  a  single  bond  issue,  and  the  number  of  classifica- 
tions in  which  this  one  issue  might  be  placed,  make  it  exceed- 
ingly difficult  to  formulate  a  simple,  and  at  the  same  time  in- 
clusive, classification.  Consequently,  every  classification  yet 
constructed,  has  been  subject  to  criticism.  Any  division  into 
classes,  then,  must  be  somewhat  arbitrary,  but  if  it  is  reasonably 
simple,  and  it  is  workable,  it  will  serve  the  purpose. 

Any  scientific  classification  is  for  the  purpose  of  correct 
identification  in  the  discussion  of  the  subject-matter;  beyond 
this  it  has  no  function.  Consequently,  the  purpose  of  a  classi- 
fication, though  the  discussion  of  it  logically  belongs  here,  is 
better  understood  when  a  more  complete  understanding  of  the 
subject-matter  is  obtained.  The  foregoing  is  not  intended  to 
belittle  the  importance  of  classification,  for  technical  discussion 
can  never  gain  any  degree  of  accuracy  without  an  accurate 
nomenclature.  It  is  not  an  infrequent  practice,  however,  for 
popular  writers  on  technical  subjects  to  devise  some  supposedly 
new  classification  in  order  to  appear  entirely  original  in  their 
treatment.  These  efforts  too  frequently  merely  result  in  new 
labels.  There  is  no  claim  of  originality  for  the  classification  in 
this  book.  It  follows  the  general  classification  of  bonds  now  most 
widely  accepted.  A  close  study  of  the  various  classifications 
that  have  been  made  will  show  that  they  are  all  fundamentally 
the  same,  though  they  may  vary  considerably  in  detail. 

The  frequent  misunderstanding  of  the  purpose  of  a  bond 
classification  and  the  actual  information  given  by  it,  calls  for  a 
word  of  warning.  The  multiplicity  of  names  in  bond  issues  in 
the  United  States  has  always  been  bewildering  to  the  English, 
who  have  largely  adhered  to  the  debenture  issues,  which  are  a 
general  claim  against  all  assets  and  not  a  specific  claim  against 
any  particular  assets.  Nevertheless,  there  is  no  question  that, 

200834 


38  INVESTMENT   ANALYSIS 

especially  in  the  earlier  days  of  railroad  financing,  issues  were 
floated  to  better  advantage  because  of  this  wide  use  of  nomen- 
clature. The  casual  observer  who  looks  for  the  lien  of  his  secu- 
rity in  the  name,  is  often  deceived.  The  use  of  "First"  attached 
to  prior  claims  and  all  forms  of  initial  issues,  even  to  the  most 
remote  claim  in  security,  has  led  to  much  confusion.  Even  after 
a  bond  has  been  placed  in  its  correct  general  classification,  the 
actual  lien  must  be  obtained  from  the  detailed  description  of 
the  mortgage.  Only  an  experienced  reader  of  mortgage  bond 
titles  can  easily  place  it.  The  consolidations  and  mergers  in 
railroads  and  public  utilities  have  been  the  chief  causes  for  these 
confusing  titles.  With  the  tendency  toward  the  consolidation  of 
all  issues,  we  will  in  time  have  greater  simplification,  both  in  the 
names  and  the  number  of  kinds  of  bonds  issued. 

As  a  general  rule,  priority  of  different  securities  within  the 
same  company  is  not  so  difficult  to  determine.  But  the  con- 
fusion as  to  priority  of  securities  having  the  same  lien  in  dif- 
ferent companies  is  only  relative  as  to  security.  A  general  claim 
of  one  company  will  often  be  much  more  valuable  than  any  one 
of  the  prior  liens  of  another  company.  Further,  if  there  are  a 
number  of  other  liens  junior  to  the  one  held,  it  is  not  the  policy 
now  wholly  to  disregard  the  interest  of  the  junior  claims,  though 
in  a  forced  sale  of  some  properties,  it  is  true,  prior  liens  have 
the  right  to  receive  settlement  before  any  return  is  allowed  on 
junior  claims.  In  the  reorganization  of  corporations,  junior 
liens  receive  consideration,  and  compromise  usually  takes  place 
between  the  first  and  subsequent  liens.  It  is  essential  to  recog- 
nize this  latter  fact,  both  for  the  interests  of  the  prior  holders, 
and  for  the  corporation  operations;  because  if  more  money  is 
needed,  new  bond  issues  will  be  wanted,  and  the  credit  for  these 
issues  must  be  maintained. 

Consequently,  the  great  number  of  different  liens  existing  in 
a  single  mortgage  has  precluded  the  possibility  of  giving  it  a 
simple  descriptive  name  that  would  clearly  indicate  the  lien  of 
the  security.  Both  compound  and  complex  names  have  been 
used  for  the  purpose  of  stating  the  exact  character  of  the  lien, 
but  they  have,  too  frequently,  not  accomplished  the  purpose. 


CLASSIFICATION  OF  SECURITIES  39 

To  one  familiar  with  bond  nomenclature,  these  complex  names 
do  serve  a  very  useful  purpose  in  designating  the  character  of 
the  bond,  but  even  the  experienced  investor  is  not  certain  of 
the  status  of  the  bond  without  a  careful  reading  of  the  mort- 
gage instrument.  As  previously  stated,  however,  "First," 
as  well  as  other  prefixes,  to  bond  titles,  have1  had  a  direct  sales 
value. 

To  the  experienced  investment  banker,  this  latter  point  may 
seem  to  have  been  overemphasized,  for  his  retort  is:  "What  is 
there  in  the  name  as  long  as  you  have  a  valued  lien  ? ' '  This  is 
true.  But  this  warning  is  more  particularly  addressed  to 
the  beginner,  who  is  continually  getting  into  difficulty  with 
bond  names  by  accepting  them  at  their  face  value.  He,  as 
must  be  expected,  accepts  the  name  as  being  complete,  and  tech- 
nically correct.  This  is  not  the  case,  as  all  investment  bankers 
know. 

The  four  large  classifications  of  bonds  now  generally 
accepted  are  those  based  on:  (1)  the  character  of  the  obligor; 
(2)  the  purpose  or  function  of  the  issue;  (3)  the  character  of 
the  lien  or  security;  (4)  the  manner  of  redemption,  and  evi- 
dence of  ownership  and  transfer.1 

These  classifications  make  no  pretence  of  being  exhaustive, 
but  they  do  contain  all  the  more  common  issues  now  used.  The 
student,  after  a  careful  study  of  these  classifications,  will  have 
little  difficulty  in  determining  the  meaning  of  other  new  titles, 
as  the  ' '  derivatives ' '  of  all  bond  issues  can  be  found  under  these 
four  main  divisions. 


*In  attempting  to  master  any  complicated  classification  in  which 
several  hundred  names  are  involved — and  this  can  be  universally  applied 
to  any  classification — the  reader  should  attempt  to  obtain  a  clear  under- 
standing of  the  description  of  each  individual  bond.  Rarely  is  it  advis- 
able for  him  to  commit  to  memory  a  list  of  names  forgotten  the  fol- 
lowing week.  It  is  of  far  more  use  to  understand  how  to  construct  a 
classification.  Many  students,  when  the  study  of  investments  was  first 
taken  up  in  our  college  curriculums,  naively  considered  that  they  had 
an  understanding  of  investments  when  they  had  committed  to  memory 
a  long  list  of  bonds.  Fortunately,  this  error  is  being  corrected.  The  im- 
portant point  in  the  study  of  investments,  as  in  any  scientific  treatment, 
is  to  acquire  the  ability  of  analysis — the  answer  to  the  why,  when 
and  where. 


40  INVESTMENT    ANALYSIS 

I.    CHARACTER  OF  CORPORATION  ISSUING* 
I.   CORPOBATION  BONDS. 

A.  Public  Utilities. 

1.  Electric  Light  Bonds. 

2.  Express  Company  Bonds. 

3.  Ferry  Company  Bonds. 

4.  Gas  Company  Bonds. 

5.  Interurban  Railway  Bonds. 

6.  Railroad  Bonds. 

7.  Steamship  Bonds. 

8.  Street  Railway  Bonds. 

9.  Telephone  and  Telegraph  Bonds. 

10.  Terminal  Company  Bonds. 

11.  Water  Company  Bonds. 

12.  Water  Power  Bonds. 

B.  Industrial  Bonds.     (For  illustration.) 

1.  Steel  Manufacturers. 

2.  Clay  Product  Manufacturers. 

3.  Automobile  Manufacturers,  eta.  , 

C.  Miscellaneous. 

1.  Drainage  Bonds. 

2.  Irrigation  Bonds. 

3.  Levee  Bonds. 

4.  Mining  Bonds. 

5.  Real  Estate  Bonds. 

6.  Timber  Bonds,  etc. 
II.    CIVIL  LOANS. 

A.  National  Bonds. 

B.  Territorial  Bonds. 

C.  State  Bonds. 

D.  Minor  Civil  Divisions  of  the  State. 

1.  County  Bonds. 

2.  City  and  Town  Bonds. 

3.  Special  Assessment  District  Bonds. 

4.  Township  Bonds. 

5.  Other  types.     (See  Classification  II.) 


JIt  has  seemed  best  not  to  include  the  detailed  description  of  each 
individual  bond  in  the  body  of  the  text  for  the  reasons  stated  above. 
An  alphabetic  catalogue  of  all  bonds  included  in  the  following  outlines 
is  given  in  Appendix  A.  The  student  will  find  this  more  convenient  for 
reference,  which  will  be  necessary  until  he  acquires  a  familiarity  with 
bond  nomenclature.  Montgomery  Rolins,  Money  and  Investment  (a 
dictionary  of  financial  terms)  and  also  Smith's  Financial  Dictionary, 
are  convenient  references.  Lawrence  Chamberlain's  classification  of 
bonds,  in  his  Principles  of  Bond  Investment,  has  not  been  excelled.  The 
main  headings  of  the  classification  used  by  the  author  are  similar  to 
those  of  Mr.  Chamberlain's  classification. 


CLASSIFICATION  OF  SECURITIES  41 

The  titles  and  sub-titles  of  the  classification  of  bonds  accord- 
ing to  the  obligor,  are  self-explanatory.  This  division,  together 
with  the  character-of-the-security  division,  is  the  most  important 
of  the  adopted  classification.  The  obligor-classification  is  the 
basis  of  discussion  for  the  chapters  of  the  second  division  of  this 
book  on  corporate  loans.  The  bonds  in  this  group  are  discussed 
in  detail  in  Book  II  (Corporation  Loan),  and  Book  III  (Bonds 
Whose  Primary  Security  is  Land),  and  IV  (Civil  Loans),  of  the 
text,  with  the  exception  of  Express  and  Ferry  Company  Bonds, 
which  have  been  omitted,  because  of  the  very  few  issues  out- 
standing, and  the  very  limited  number  of  investors  who  have 
any  interest  in  them.  A  very  considerable  difference  will,  as 
mentioned  in  the  preface,  be  found  in  the  completeness  of  treat- 
ment of  the  various  bonds  in  this  classification,  owing  to  the 
difference  in  the  importance  of  the  issues  and  to  the  amount  of 
material  available.  Railroad  bonds,  because  of  their  preemi- 
nence, are  given  the  most  complete  treatment.  Any  individual 
reference  to  irrigation,  levee,  and  drainage  bonds  under  civil 
laws  has  been  omitted.  The  special  characteristics  of  these 
latter  bonds  make  them  more  nearly  akin  to  the  corporate  group 
than  to  civil  obligations. 

Civil  loans  include  both  the  Federal  and  state  issues,  and 
those  of  the  minor  civil  divisions.  The  former  entirely  depend 
upon  the  good  faith  of  the  government,  but  the  latter  are  also 
subject  to  action  at  law,  by  the  purchaser  of  the  corporate 
securities.  Territorial  bonds  of  all  national  governments  are 
practically  always,  as  with  the  territory  issues  of  the  United 
States,  authorized  by  the  Federal  government.  The  Philippines 
and  Hawaiian  issues,  though  not  an  obligation  of  the  United 
States,  are  authorized  by  Congress,  and  are  also  made  tax 
exempt  in  the  United  States.  The  Panama  issues  are  a  direct 
obligation  of  the  United  States  government.  The  District  of 
Columbia  issues,  a  direct  obligation  of  this  district,  are  also 
secured  by  the  additional  pledge  of  the  Federal  government.1 

Before  the  European  war  the  bonds  of  the  national  govern- 


JThe  beginning  student  of  national  issues  should  be  careful  not  to 
confuse  the  United  States  "Consols"  with  the  securities  issued  by  the 
Government  of  Great  Britain  called  "consols"  (sometimes  called 
Goschen's). 


42 


INVESTMENT   ANALYSIS 


ment,  with  few  exceptions,  were  purchased  only  by  banks  and 
other  financial  institutions  and  by  large  investors  seeking  tax- 
exempt  securities.  As  a  result  of  the  campaign  during  the  War 
for  the  sale  of  Liberty  loans,  the  holders  of  national  bonds  now 
reach  into  the  millons.  Though  a  very  considerable  reduction 
in  the  number  of  holders  of  Liberty  bonds  and  other  European 
war  bonds  will  take  place  in  the  next  few  years,  there  will  still 
be  a  large  number  of  individual  holders  of  war  issues. 


II.     CLASSIFICATION  ACCORDING  TO  THE  PURPOSE 


A. 

1. 
2, 

3. 
4. 

5. 
6. 


9. 

10. 
11. 
12. 
13. 
14. 
15. 
16. 
17. 
18. 
19. 
20. 
21. 
22. 
23. 


FOUND  PRIMARILY  IN 

MUNICIPAL  ISSUES. 
Anticipation  Tax  Warrants. 
Charter  Bonds. 
Delinquent  Tax  Certificates. 
Drainage  Bonds. 
Improvement  Bonds. 
Intercepting    (all  types  Sewer 

Bonds). 

Irrigation  Bonds. 
Judgment  Bonds. 
Levee  Bonds. 
Paving  Bonds. 
Railroad  Aid  Bonds. 
Reclamation    Bonds. 
Revenue   Bonds  or  Notes. 
Road  Bonds. 
Sanitary  District  Bonds. 
School  District  Bonds. 
Sewer  Bonds. 
Special  Assessment  Bonds. 
Street  Bonds. 
Subsidy  Bonds. 
Tax  Arrearage  Bonds. 
Tax  Relief  Bonds. 
Water  Bonds. 


B.   FOUND  PRIMARILY  IN 
CORPORATION  ISSUES. 

1.  Adjustment  Bonds. 

2.  Bonus  Bonds. 

3.  Bridge  Bonds. 

4.  Consolidated  Bonds. 

5.  Construction  Bonds. 

6.  Continued  Bonds. 

7.  Development  Mortgage  Bonds. 

8.  Dock  Bonds. 

9.  Extended  Bonds. 

10.  Extension  Bonds. 

11.  Ferry  Bonds. 

12.  Founders  Bonds. 

13.  Funding  Bonds. 

14.  Indemnity  Bonds. 

15.  Interim  Certificates. 

16.  Purchase  Line  Mortgage. 

17.  Purchase  Money  Bonds. 

18.  Receiver's  Certificates. 

19.  Redemption  Bonds. 

20.  Refunding  Bonds. 

21.  Renewal  Bonds. 

22.  Temporary    Bonds    or    Certifi- 

cates. 

23.  Terminal  Company  Bonds. 

24.  Unifying  Bonds. 

25.  Wharf  and  Dock  Bonds. 


Again,  as  with  the  classification  according  to  the  obligor,  the 
classification  according  to  the  purpose  of  the  issue  is  often 
implied  in  the  title  of  the  issue.  In  a  few  cases,  it  will  be  noted, 
the  designation  of  the  title  is  of  the  utmost  importance;  in 


CLASSIFICATION  OF  SECURITIES  43 

others,  it  has  no  very  important  significance  and  does  not  com- 
pletely tell  the  purpose  of  the  bond  issue.  A  designation  of 
bond  as  a  school  bond,  railroad  aid  bond,  or  refunding  bond, 
is  valuable,  though  in  the  latter  case  it  does  not  state  what 
property  the  funds  have  financed.  Any  study  of  this  classifi- 
cation must  recognize  these  limitations. 

III.  CLASSIFICATION  ACCORDING  TO  THE  CHARACTER  OF  THE  LIEN. 
I.    Bonds  with  General  Claims. 

A.  Civil  Loans. 

1.  Bonds. 

2.  Certificates. 

3.  Notes. 

B.  Corporate  Debentures. 

1.  Debenture  Bonds. 

2.  Debenture  Income  Bonds. 

3.  Debenture  Mortgages. 

4.  Debenture  Mortgage  Bonds. 

5.  Income  Bonds  (Abbreviation.) 

6.  Plain  Bonds. 

7.  Preference  Income   Bonds. 

8.  Receivers  Certificates. 

II.    Bonds  with  Secured  Claims. 

A.  Personal  Security. 

1.  Assumed  Bonds. 

2.  Guaranteed  Bonds. 

3.  Indorsed  Bonds. 

4.  Joint  Bonds. 

5.  Stamped  Bonds. 

B.  Lien  Security. 

(X)    Character  of  Property  Pledged, 
a.  Personal  Property. 

1.  Collateral  Trust  Issues. 

(a)  Certificates  of  Beneficial  Interest.1 

(b)  Certificates  of  Indebtedness. 

(c)  Collateral  Income  Bonds. 

(d)  Collateral  Mortgages. 

(e)  Collateral  Notes. 

(f )  Collateral  and  Participating  Bonds. 

(g)  Collateral  Trust  Bonds. 


'Certificates   of   Beneficial  Interest  are  frequently    abbreviated   to 
Trust  Certificates. 


44  INVESTMENT    ANALYSIS 

(h)  Joint  Collateral  Trust  Bonds, 
(i)    Mortgage  Collateral  Trust  Bonds, 
(j)    Eailway  Trust  Bonds, 
(k)   Residuary  Estate  Bonds. 
(1)    Stock  Interest  Certificates, 
(m)  Stock  Trust  Certificates. 

2.  Sinking  Funds  (all  types). 

3.  Equipment  Securities. 

(a)  Car  Trust  Certificates. 

(b)  Car  Trust  Bonds. 

(c)  Equipment  Bonds. 
b.   Real  Property. 

1.  Extension  Bonds  (on  all  types  of  property), 

2.  Farm  Mortgage  Bonds. 

3.  Land  Grant  Bonds. 

4.  Municipal  Mortgages. 

5.  Real  Estate  Bonds. 

G.  Real  Estate  Mortgage  Bonds. 
(Y)  By  the  character  of  the  Priority  of  the  Lien. 

1.  Blanket  Mortgage  Bonds. 

2.  Consolidated  Issues    (see  Collateral  Issues). 

(a)  Consolidated  Mortgage  Bonds. 

(b)  Consolidated  and  Refunding  Mortgage  Bonds 

(c)  Consolidated  First  Mortgage  Bond?. 

(d)  First  and  Consolidated  Mortgage  Bonds. 

(e)  Second  Consolidated,  Third  Consolidated,  etc. 

3.  Debenture  Mortgage  Bonds. 

4.  First,  Second,  Third,  etc.,  Mortgage  Bonds. 

6.  First  Lien  Bonds. 

f).  First  Lien  and  General  Mortgage  Bonds. 

7.  First  Mortgage  and  Trust  Bonds. 

8.  First  Trust  Mortgage  Bonds. 

9.  General  Mortgage  Issues. 

(a)  First  and  General  Mortgage  Bonds. 

(b)  First  General  Mortgage  Bonds. 

(c)  General  and  First  Mortgage  Bonds. 

(d)  General  First  Mortgage  Bonds. 

(e)  General  Mortgage  Bonds. 

10.  Improvement  Mortgage  Bonds. 

11.  Mortgage  Debentures. 

12.  Mortgage  Income  Bonds. 

13.  Overlying  Bonds. 

14.  Preferential  Bonds. 

15.  Prior  Lien  Bonds. 

16.  Refunding  Issues  (see  Collateral  Issues). 


CLASSIFICATION  OF  SECURITIES  45 

(a)  Refunding  Mortgage  Bonds. 

(b)  Refunding  First  Mortgage  Bonds. 

(c)  First  and  Refunding  Mortgage  Bonds. 

17.  Senior,  Junior  Bonds. 

18.  Underlying  Bonds. 

19.  Unifying  Bonds. 

III.  Bonds  with  Security  Liens,  but  having  special  qualifying  additions 
to  the  Mortgage.  (All  bonds  for  a  designated  purpose  could  be 
included  in  this  subdivision.) 

1.  Assented  Bonds. 

2.  Extension  Bonds. 

3.  Joint  Bonds. 

4.  Joint  Collateral  Trust  Bonds. 

5.  Leasehold  Mortgage  Bonds,  etc. 

The  classification  of  bonds  according  to  security  of  the  lien 
is  one  of  the  most  important,  and  it  is  also  the  one  which  must 
be  closely  scrutinized.  A  few  of  the  general  features  upon 
which  the  classification  is  based  should  be  noted  to  obtain  a 
more  complete  appreciation  of  the  lien  of  the  individual  bond. 

Liens  upon  property  naturally  fall  into  two  classes:  those 
which  have  a  general  claim  and  those  which  have  a  specific- 
claim  upon  property.  No  classification  has  been  found  by  any 
author  that  adequately  describes  the  former  group.  Instead  of 
classifying  all  general  claims  under  one  head,  it  might  be  the 
better  plan  to  separate  entirely  the  civil  and  debenture  group 
and  place  them  under  two  distinct  headings.  In  civil  loans 
(either  Federal  or  state),  the  holder  has  no  resort  for  recovery 
if  the  bonds  are  repudiated,  for  the  only  security  possessed  is 
the  good  faith  of  the  nation  or  state.  To  say  that  a  civil  loan 
is  merely  a  general  claim,  however,  does  not  adequately  describe 
the  characteristics  of  all  civil  loans.  The  bond  issues  of  the 
minor  civil  divisions  do  have  a  claim  against  taxes  and  this  legal 
claim  against  the  minor  civil  divisions  does  make  this  type  of 
bond  a  general  form  of  claim  on  the  civil  divisions  for  these 
securities. 

The  lien  of  the  bonds  in  the  property  security  classifica- 
tion (B)  is  represented  by  a  direct  and  specific  claim  upon  the 
whole  or  a  certain  given  amount  of  the  assets  of  the  corporation. 
If  the  company  fails  to  meet*  any  of  these  accruing  obligations, 


46 


INVESTMENT   ANALYSIS 


and  foreclosure  proceedings  are  made,  these  obligations  have 
claims  on  the  property,  according  to  the  priority  of  their  liens. 
The  caution  expressed  earlier,  of  knowing  the  exact  lien  in 
bond  purchases,  needs  no  further  reiteration  here. 

Under  property  secured  issues,  there  are  two  general  types 
of  lien :  those  on  personal  property  and  those  on  real  property. 
Personal  property,  here,  must  not  be  confused  with  personal 
security;  the  security  of  the  former  is  in  the  form  of  actual 
tangible  security  and  the  latter  is  merely  an  agreement 
by  endorsement  or  otherwise,  guaranteeing  the  payment,  but 
with  no  assets  given  in  security. 


IV.    ACCORDING  TO  METHODS  OF  PAYMENT  AND  REDEMPTION 


I.  PAYMENT    AND    REDEMPTION    OF 

PRINCIPAL. 

1.  Callable  Bonds. 

2.  Convertible  Bonds. 

3.  Convertible     Collateral     Trust 

Bonds. 

4.  Convertible  Debentures. 

5.  Convertible  Income  Bonds. 
G.  Continued  Bonds. 

7.  Currency  Bonds. 

8.  Deferred  Bonds. 

9.  Drawn  Bonds. 

10.  Equal  Installment  Bonds. 

II.  Extended  Bonds. 

12.  Gold  Bonds. 

13.  Irredeemable  Bonds. 

14.  Installment  Bonds. 

15.  Legal  Tender  Bonds. 

16.  Optional  Bonds. 

17.  Perpetual   Bonds. 

18.  Preference  Bonds. 

19.  Premium  Bonds. 

20.  Redeemable  Bonds. 

21.  Serial  Bonds. 

22.  Silver  Bonds. 


II.  PAYMENT  OF  INTEREST. 

1.  Coupon  Bonds  and  Notes. 

2.  Cumulative  and  Non-cumulative 

Income  Bonds. 

3.  Dividend    Sharing   Bonds    (lin 

ited  and  unlimited). 

4.  Interchangeable  Bonds. 

5.  Profit-sharing  Bonds. 

6.  Registered  Bonds. 

7.  Registered  Coupon  Bonds. 


In  the  fourth  group  no  reference  to  any  particular  class  of 
the  group  seems  necessary  other  than  the  explanation  of  the 
individual  description  of  the  bond  found  in  the  appendix.  These 


CLASSIFICATION  OF  SECURITIES  47 

bond  titles,  as  in  all  the  former  bonds,  permit  of  many  combina- 
tions. In  their  simpler  form,  the  titles  convey  their  full  mean- 
ing as  clearly  as  do  the  titles  of  Division  I. 

In  the  first  division  of  the  Payment  of  Interest,  the  name  or 
description  of  the  bond  will  give  the  reader  sufficient  informa- 
tion of  this  class.  The  legal  aspects  of  registered  coupon  and 
interchangeable  bonds  with  which  the  student  should  be  fully 
familiar  are  covered  in  two  subsequent  chapters. 

In  the  classification  of  the  methods  of  payment,  many  debat- 
able questions  arise  as  to  the  advantages  or  disadvantages  to  the 
investor  of  each  of  the  particular  methods.  Too  frequently, 
these  discussions  have  been  wholly  based  upon  the  method  or 
methods  without  reference  to  the  obligor  or  the  needs  of  the 
investor.  More  often,  no  distinction  has  been  made  between  the 
types  of  corporations  or  between  municipalities  and  corpora- 
tions, the  same  method  being  urged  for  all  without  qualification. 

Before  leaving  the  subject  of  the  classification  of  bonds, 
some  special  reference  should  be  made  to  the  methods  of  pay- 
ing off  bond  issues.  The  two  most  common  methods  are  by 
means  of  the  sinking  fund  and  the  serial  payment.  The  sink- 
ing fund  provides  for  a  regular  annual  sum  to  be  set  aside 
from  earnings  for  the  purpose  of  retiring  the  bonds  at  maturity. 
This  "fund  may  be  accumulated  by  the  purchase  of  the  securi- 
ties of  other  corporations  or  by  the  purchase  of  the  bond  issue 
itself.  In  the  latter  case  the  bonds  are  either  cancelled  or 
carried  as  treasury  securities.  Since  these  latter,  which  can 
command  only  the  low  savings  bank  rate,  are  too  costly,  the 
latter  method  is  rarely  used. 

The  history  of  the  sinking  funds1  during  the  railroad  receiv- 
ership of  1893  and  1894  left  this  form  of  financing  for  a  time 
in  bad  repute.  Frequently,  even  new  issues  were  made  to  pro- 
vide for  these  funds,  with  a  resultant  increase  of  the  debt.  A 
more  frequent  fault  of  many  of  these  earlier  sinking  fund  pro- 
visions was  their  loose  construction,  and  the  consequent  disre- 
gard of  the  requirements.  This  situation  cannot  all  be  laid  at 


"The  history  of  the  sinking  fund  extends  back  to  1716,  when  Eng- 
land's Sinking  Fund  Plan  was  cheated.  There  is  a  considerable  amount 
of  literature  on  the  Sinking  Fund,  as  applied  to  National  Loans. 


48  INVESTMENT    ANALYSIS 

the  door  of  the  sinking  fund.  Railroads  which  had  been  over- 
built in  earlier  days  might  have  gradually  overcome  these 
difficulties  if  a  financial  panic  had  not  taken  place;  but  the 
weakened  financial  condition  in  which  they  started  forced  their 
collapse,  and  under  these  conditions  any  system  of  repayment 
would  have  failed. 

Following  this  chapter  of  failures  in  railroad  history,  many 
changes  were  made  in  the  sinking  fund  provisions,  which  even 
now,  are  by  no  means  perfect.1  Companies  subject  to  the 
exhaustion  of  their  assets,  such  as  mining  and  lumbering  com- 
panies, were  an  exception,  and  were  forced  to  protect  their 
sinking  funds  in  order  to  secure  credit.  Other  companies  soon 
saw  the  advantage  and  made  needed  changes.  These  changes 
and  the  theoretically  stronger  position  which  the  credit  of  the 
company  possessed  by  the  accumulation  of  a  fund  soon  brought 
the  practice  of  the  sinking  fund  back  into  active  use,  especially 
with  industrials,  which  have  sinking  fund  provisions  attached 
to  three-fourths  of  their  issues. 

Of  the  two  questions  which  have  presented  themselves  in 
connection  with  the  sinking  fund,  the  first  is  primarily  viewed 
from  the  corporate  management  side,  though  it  also  directly 
affects  the  investor.  The  common  practice  of  corporations  in 
the  handling  of  the  sinking  fund  has  been  to  place  the  accumu- 
lation back  into  the  property.  Exceptions,  of  course,  must  be 
made  to  this;  for  example,  small  corporations  with  rapidly 
depreciating  assets,  or  cases  where  the  actual  capital  assets 
are  used  up  (as  in  mining  companies)  to  provide  income. 
With  the  large  well  financed  corporation,  it  may  be  well  argued 
that  the  company's  credit  is  more  effectively  strengthened  by 
placing  the  surplus  earnings  back  into  the  property  and  requir- 
ing certain  conditions  to  be  met  than  by  putting  the  annual 
sums  paid  into  a  cash  fund,  with  a  trustee.  The  placing  of 
funds  back  into  the  property  would  be  less  expensive  to  the 
corporation,  and  as  earning  power  is  the  ultimate  test  even  with 
large  assets,  credit  should  be  strengthened  by  this  provision  if  it 


Francis  Lynde  Stetson,  Lecture  I   (m)  Some  Legal  Phases  of  Cor- 
poration Financing,  Reorganization  and  Regulation  (1911),  pp.  1-76. 


CLASSIFICATION  OF  SECURITIES  49 

results  in  increased  earnings.  If  this  policy  is  not  permitted  in 
the  corporations  which  are  justified  in  using  this  method,  is  it 
not  a  decided  disadvantage  to  have  funds  annually  withdrawn 
from  the  business?  From  the  standpoint  of  corporate  manage- 
ment, it  is  conceded  the  soundest  policy  to  borrow  up  to  the 
point  of  safety,  as  that  means  a  larger  return  to  the  corporate 
owners.  This  would  not,  of  course,  as  previously  acknowledged, 
apply  to  such  corporations  as  coal  mines  where  the  principal 
itself  is  being  gradually  depleted,  or  to  unstable  industries  or 
to  civil  loans.  It  would  also  be  well  to  place  in  the  latter  class 
the  corporations  that  do  not  make  liberal  allowances  for  main- 
tenance, etc.  There  is,  then,  a  strong  argument  for  permanency 
in  corporate  loans  by  means  of  the  use  of  refunding  issues  or 
the  extension  of  the  duration  of  sound  issues  by  common  con- 
sent, rather  than  the  accumulation  of  a  sinking  fund  to  retire 
the  issues  at  maturity. 

When  the  sinking  fund  is  used,  the  character  and  control  of 
the  trusteeship  are  the  important  considerations  to  the  investor. 
To  make  the  sinking  fund  a  mere  bookkeeping  procedure,  is  worse 
than  having  no  sinking  fund,  as  the  entries  belie  the  existence 
of  a  tangible  fund.  The  temptation  of  manipulation  is  then 
greater  and  the  funds  have  frequently  been  put  back  into  the 
properties  and  the  properties  have  depreciated.  If  the  inden- 
ture clearly  states  that  the  bonds  are  to  be  purchased  and  paid 
off  by  the  accumulation  of  the  sinking  fund,  there  is  little  dan- 
ger of  this  complication.  If  the  sum  is  held  to  maturity,  the 
regulation  and  guardianship  of  the  fund  must  be  carefully 
protected. 

The  serial  payment  is  unqualifiedly  advocated  by  several 
leading  authorities,  as  the  only  safe  plan  for  paying  off  bond 
issues.  Their  reasons  for  judging  the  sinking  fund  method  to 
be  unsound  are  briefly:  (1)  the  failure  of  the  actual  working 
of  the  sinking  fund,  as  illustrated  in  the  great  railroad 
receiverships  of  1893;  (2)  the  ease  with  which  the  fund  may  be 
manipulated  and  the  temptation  to  do  so  when  the  corporation 
gets  into  financial  difficulty;  (3)  the  difficulty  of  investing  the 
fund  with  an  equivalent  rate  o.f  return,  particularly  where  these 
limitations  are  placed  upon  it  for  its  own  protection;  (4)  lastly, 


50  INVESTMENT  ANALYSIS 

the  greater  cost  to  the  corporation  than  by  the  serial  retirement 
of  bonds. 

With  municipal  issues,  and  issues  of  corporations  whose 
assets  depreciate  rapidly,  such  as  rolling-stock  and  telephone 
equipment,  or  whose  capital  assets  are  depleted  in  furnishing 
income  such  as  mining  corporations,  the  serial  form  is  un- 
deniably the  soundest  method  of  retiring  bonds.  In  municipal 
issues,  it  is  a  saving  to  the  taxpayers,  as  will  be  explained  in 
detail  in  a  subsequent  chapter  on  civil  loans,  as  well  as  the 
most  effective  method  of  promoting  conservative  financing  in 
municipalities.  In  the  growing  tendency  of  over-expenditures, 
the  deferring  of  obligations  to  a  distant  future  date  is  likely  to 
result  in  reckless  expenditure,  especially  where  the  politicians 
are  attempting  to  court  public  favor.  When  payments  are  to 
be  met  in  the  more  immediate  future,  a  tax  must  be  raised,  and 
an  increase  in  taxes  is  not  voted  without  serious  thought.1  In 
both  types  of  corporations  in  which  the  serial  method  of  pay- 
ment is  advocated,  the  argument  that  this  method  promotes 
conservative  financing  is  also  applicable. 


*For  an  opposite  view  to  this  opinion  see  Edmund  D.  Fischer,  Muni- 
cipal Financing,  Second  Annual  Proceedings  of  the  American  Invest- 
ment Bankers'  Association,  pp.  57-76  (1913 j. 


CHAPTER  IV 
ANALYSIS  OF  THE  CORPORATION  REPORT 

Corporate  organizations  are  beginning  to  supply  sufficient 
public  information  to  warrant  the  scientific  analysis  of  their 
financial  condition.  A  considerable  number  of  corporations  are 
also  continually  making  serious  efforts  to  correct  the  early  errors 
in  the  collection  and  assemblage  of  data.  On  the  other  hand, 
it  must  always  be  recognized  that  the  greater  facility  with  which 
some  types  of  organizations  lend  themselves  to  analysis  will 
mean  a  considerable  degree  of  difference  in  the  thoroughness  of 
analysis  among  different  types  of  businesses. 

There  are  other  organizations  whose  methods  of  collecting 
and  analyzing  data  concerning  their  own  condition  have  been 
retarded  by  adherence  to  old  customs  and  practices.  In  some 
corporations  better  cost  systems  are  needed,  which  will  enable 
closer  analysis  of  the  corporations'  financial  condition.  Accu- 
rate cost  systems  eliminate  guess  work.  A  large  and  old  con- 
cern was  recently  placed  in  its  creditors'  hands  because  of  its 
bad  cost  system.  Even  the  president  of  this  particular  com- 
pany had  thought  his  company  was  making  good  profits.  We 
have  still  much  to  learn  in  this  matter  from  the  English  and 
French  practices  in  corporation  analysis.  It  must  not  be 
inferred,  however,  that  an  accurate  knowledge  of  costs  is  the 
only  thing  necessary  to  make  a  strong  organization.  Costs  are 
only  given,  as  one  method  in  illustrating  the  kind  of  accuracy 
needed  in  analysis. 

Neither  does  this  imply  that  all  factors  necessary  to  a  com- 
plete analysis  can  be  measured  with  the  exact  nicety  of  a  cost 
system.  For  who  can  measure  the  reputation  of  the  Pennsyl- 
vania system,  or  the  influence  of  one  of  the  great  leaders  of 
industry  with  a  thumb  rule?  As  one  proceeds  in  his  study  of 
securities,  he  is  soon  made  aware  of  both  the  many-sidedness  and 

51 


52 

essential  elasticity  which  must  be  given  certain  factors  and  the 
minute  exactitude  required  of  others.  Experience  alone  can  give 
a  full  appreciation  of  this.  Statistical  data  which  would  have 
been  invaluable  in  an  analysis  if  they  had  been  correctly  inter- 
preted and  adapted  to  local  conditions,  have  not  infrequently 
led  to  wrong  conclusions.  There  are,  for  example,  more  vari- 
ables in  other  classes  of  public  utilities  than  in  railroads,  and 
more  variables  in  industrials  than  in  public  utilities. 

Some  territories  occupied  by  public  utilities  must  always  be 
subject  to  a  wider  range  of  risks  which  greatly  increase  the 
difficulty  of  applying  any  set  statistical  method  of  analysis  to 
public  utilities  in  general.  Some  industries  and  utilities  are 
new,  and  the  standardization  that  comes  with  years  of  develop- 
"  ment  is  just  beginning  for  them.  And  considerable  standardi- 
zation must  be  attained  in  any  industry  before  an  analysis  can 
be  much  simplified.  An  industry  long  in  existence,  likewise, 
gives  the  accountant  and  statistician  an  opportunity  of  know- 
ing the  character  of  its  reactions  under  varying  conditions,  a 
fact  which  makes  more  accurate  conclusions  possible.  Experi- 
ence has  also  demonstrated  that  the  ability  to  analyze  a  cor- 
poration report  depends  as  much  upon  the  ability  to  foresee  and 
understand  the  effect  of  readjusted  relationships  as  upon  an 
ability  to  understand  the  technical  details  of  the  reports  them- 
selves. The  close  dependence,  also,  of  the  internal  affairs  of 
the  corporation  upon  the  external  conditions  of  the  markets, 
and  the  inter-relation  between  these  two  factors,  have  so  fre- 
quently led  to  a  confusion  of  what  is  cause  and  what  is  effect, 
that  a  sharp  distinction  should  be  made  between  each  one  of 
these  factors  in  an  analysis.  No  corporation  has  long  been  suc- 
cessful \vhich  has  been  unable  to  make  this  distinction.  No 
single  source,  consequently,  is  adequate. 

Before  passing  to  a  discussion  of  the  corporation  report  itself, 
a  statement  should  be  made  concerning  the  exact  functions  of 
the  experts  who  assist  the  investment  banker  by  assembling  the 
data  for  him.  As  is  well  known,  for  bringing  together  of  the 
corporation  reports  and  determining  the  accuracy  of  the  finan- 
cial statements  given  to  the  banker  by  the  corporation,  we  are 
dependent  upon  the  accountant.  The  fact,  however,  that  a  cer- 


ANALYSIS  OF  REPORT  53 

tified  public  accountant  has  signed  his  name  to  the  official 
report  of  a  company  should  not  be  accepted  as  final  evidence  as 
to  the  value  of  the  figures  in  the  statement  until  the  exact  intent 
of  this  certification  is  known.  Furthermore,  certifications  by 
public  accountants  are  too  frequently  given  a  common  status. 
There  is  as  much  difference  in  the  character  and  thoroughness 
of  the  work  done  by  these  auditors  as  there  are  differences  in  the 
abilities  of  bankers  or  in  managerial  efficiency  of  industrial  cor- 
porations. The  officials  desiring  that  certain  things  appear  in 
their  public  report  will  employ  the  public  auditor  who  will  do 
as  they  direct. 

Of  the  several  considerations  in  an  audit,  the  following 
should  be  checked :  ( 1 )  Have  the  books  been  audited  by  a  certi- 
fied public  accountant  and  what  is  his  reputation;  (2)  what 
does  the  certificate  signed  by  the  accountant  indicate  that  the 
accountant  claims  to  have  done.  Too  frequently  more  is  read 
into  the  certification  than  was  intended.  In  some  instances,  the 
certificate  means  merely  a  balance  of  the  company's  statements 
issued,  without  any  verification  of  the  detail  figures  which  make 
up  these  balances.  In  other  cases  the  audit  may  include  only 
the  audit  of  certain  corporation  books  without  again  checking 
the  various  entries  into  these  books.  Audits  have  been  made 
and  are  still  being  made  in  which  the  books  of  the  holding  com- 
pany are  audited,  but  no  check  is  made  upon  the  books  of  the 
subsidiary  companies.  While  no  false  certificate  may  have  been 
signed  in  any  one  of  these  cases,  any  conclusions  based  on  these 
statements  may  give  false  results.  Criticism  of  such  practices 
cannot  be  too  severe,  especially  if  these  reports  are  to  be  issued 
to  the  general  public.  It  would  indeed  be  desirable  if  no  public 
auditor  were  allowed  to  certify  a  corporation  report  unless  he 
has  checked  not  only  the  balances  but  as  well  ascertained  the 
reliability  of  the  accounts  or  entries  which  are  used  to  make  up 
these  balances. 

In  addition  to  the  guarantee  of  the  complete  checking  of  the 
items  and  the  accuracy  of  the  statements  issued,  complete 
enough  statements  should  be  demanded  by  the  investor  to  enable 
him  to  draw  deductions  and  to  analyze  the  reports.  While  the 
statements,  incomplete  as  to  details,  may  be  accurate,  any  deduc- 


54  INVESTMENT  ANALYSIS 

tions  drawn  from  them  would  be  erroneous.  The  only  safe 
deductions  which  can  be  drawn  from  a  statement  are  from  one 
which  is  certified  as  to  accuracy  and  one  which  is  complete  as  to 
detail.  There  is  no  other  means  by  which  the  investor  will  be 
enabled  to  follow  accurately  the  success  of  any  corporation — 
consequently  these  two  requirements  should  be  insisted  upon. 
This  must  not,  however,  be  understood  to  mean  an  interpreta- 
tion of  the  value  of  the  securities  issued  by  the  corporation, 
though  the  accountant  may  make  a  very  complete  and  detailed 
interpretation  in  his  confidential  report  to  the  banker  under- 
writing the  security  issue.  The  public  auditor  no  more  than 
the  state  officials  giving  their  sanction  to  an  issue,  should  ever 
render  an  interpretation  in  a  public  report. 

As  the  valuation  of  a  corporation's  physical  property  is 
wholly  a  technical  problem,  the  layman  must  leave  it  to  an 
expert.  Consequently,  the  worth  of  the  valuation  must  be 
judged  indirectly  by  the  reliability  of  the  engineer  making  it. 
If  the  valuation  has  been  made  by  the  state,  even  though  less 
accurate  than  the  valuation  by  a  private  enterprise,  it  may  often 
be  more  useful  to  the  investor,  since  it  is  the  valuation  upon 
which  will  be  based  the  rates,  as  well  as  the  amount  of  the 
securities  that  the  company  will  be  permitted  to  issue.  Conse- 
quently, when  securities  are  issued  upon  a  public  utility  prop- 
erty, it  is  absolutely  essential  that  the  value  of  the  properties 
shall  be  passed  upon  by  a  technical  expert.  While  the  practice 
of  valuating  industrial  properties  is  now  more  frequent  than 
formerly,  the  practice  is  by  no  means  common,  though  it  is  as 
important  as  the  auditing  of  the  accounts.  Accountants  fre- 
quently pass  upon  the  physical  valuation  of  the  plant  in  their 
audits,  but,  as  experience  has  shown,  this  is  an  unsafe  proced- 
ure. Though  physical  valuation  in  the  great  percentage  of  the 
industrial  corporations  is  not  as  important  as  in  public  utilities, 
where  fixed  properties  are  such  a  large  item,  there  are  a  suffi- 
cient number  in  which  the  fixed  property  is  large,  and  the 
physical  valuation  necessary.  While  fixed  property  is  of  no 
value  without  a  strong  earning  basis,  conservative  procedure  in 
bond  issues  usually  demands  fixed  property  with  large  margins 
as  security. 


ANALYSIS  OF  REPORT  55 

The  banker,  or  the  financial  analyst,  in  turn  is  compelled  to 
go  to  other  experts  for  legal  examination  of  the  instruments  of 
issue.  The  lack  of  standardization  in  statutes  and  judicial  deci- 
sions and  their  multiplicity  will  always  make  us  dependent  upon 
the  attorneys'  final  sanction  of  an  instrument's  legality.  If  the 
reputability  and  ability  of  the  attorneys  are  assured,  the 
investor  can  with  little  hesitancy  accept  the  terms  of  the  mort- 
gage as  valid. 

The  misunderstanding  on  the  part  of  the  investor  has  often 
been  not  in  the  legality  of  the  investment,  but  in  a  misinterpre- 
tation of  the  position  of  the  lien  in  relation  to  other  liens,  or  of 
the  actual  property  covered  by  the  mortgage.  This  error  arises, 
not  as  frequently  claimed  by  the  investor,  through  the  fault  of 
the  attorney,  but  through  the  failure  of  the  investor  himself  to 
read  the  mortgage,  or  to  ascertain  from  other  reliable  sources 
the  specific  character  of  the  lien.  This  is  usually  a  failure  on 
his  part  to  distinguish  between  mere  legality  and  the  consti- 
tuency of  the  lien.  The  attorney's  function  is  merely  to  deter- 
mine whether  the  lien  stipulated  in  the  instrument  is  valid, 
and  what  the  specific  lien  is,  if  interpretation  is  needed,  and  not 
to  pass  upon  the  value  of  these  liens.  The  value  of  the  lien, 
the  legality  being  assured,  depends  on  the  character  of  the  com- 
pany, and  the  position  of  the  lien,  and  this  latter  can  be  deter- 
mined only  by  a  reading  of  the  mortgage  or  by  consulting  the 
bankers. 

Management,  Control  and  Organization. — Despite  the  effici- 
ency which  the  modern  corporation  has  attained  in  organization, 
the  personnel  of  the  managing  staff  continues  as  a  strong  factor 
in  the  consideration  of  a  corporation's  position  in  the  industrial 
world.  "While  an  established  policy  of  a  corporation  may  con- 
tinue in  public  confidence  for  a  period,  this  confidence  will  not 
long  remain  without  a  strong  management  at  the  head.  The 
ability  of  the  head-executive  becomes  increasingly  important, 
with  the  increasing  size  of  the  corporation.  In  the  large  cor- 
poration, however,  the  opportunity  that  the  size  gives  for  more 
effective  organization  and  the  wider  group  of  individuals  from 
which  it  has  to  select  its  officials,  give  this  class  of  corporation  a 
decided  advantage. 


56  INVESTMENT  ANALYSIS 

As  a  class,  the  price  of  railroad  securities  and  the  earning 
capacity  of  the  company  would  be  less  affected  by  a  change  in 
personnel,  than  in  any  other  type  of  corporation,  and  these  are 
the  things  which  most  concern  the  investor.  But  even  with 
the  highly  developed  organization  of  railroads  today,  it  is 
questionable,  indeed,  whether  certain  railroad  heads  do  not 
stand  out  more  strikingly  than  the  name  of  their  own  company 
because  of  their  executive  ability.  The  larger  centralized  public 
utility  organizations,  as  a  class,  rank  next  to  railroads  in  the 
power  of  their  continuation.  The  rapid  development  and 
changes  in  the  industry  wrought  through  new  inventions  in  the 
creating  and  control  of  electricity  have  made  the  personnel 
equation,  however,  a  relatively  more  important  factor  than  in 
railroads.  While  the  highly  developed  organizations  are  recog- 
nized as  organizations,  apart  from  their  leaders,  nevertheless, 
certain  members  of  these  organizations  stand  out  in  the  public 
mind  as  the  controlling  and  directing  geniuses  of  the  concern. 

Industrial  corporations,  more  than  railroads  and  other 
public  utility  corporations,  reflect  the  influence  of  a  particular 
management.  Industrials,  unlike  public  utilities,  are  dependent 
upon  their  superiority  in  overcoming  competition.  Industrials, 
unlike  most  public  utilities,  with  the  exception  of  extraordi- 
narily rare  cases,  do  not  possess  a  monopoly.  Neither  is  mere 
size  and  the  economies  supposedly  attached  to  large  corporations 
a  substitute  for  managerial  prerequisites.1  Even  so-called  fun- 
damental patents  are  not  entirely  immune  from  meeting  severe 
competition  in  new  patents  and  processes.  The  recognition  of 
this  possibility  has  led  conservatively  managed  corporations  to 
write  off  the  original  valuation  of  these  items  and  carry  them 
at  a  small  nominal  price.  This  does  not  mean  that  a  company 
which  does  take  a  risk  must  be  eliminated  from  any  considera- 
tion by  the  investor.  No  company  is  ever  progressive  that  does 
not  take  risks.  But  in  the  long  run  the  company  that  most 


'For  illuminating  discussions  and  illustrations  see:  A.  S.  Dewing, 
"The  Law  of  Balanced  Return."  Amer.  Econ.  Rev.,  vol.  vii  (Dec.,  1917), 
pp.  755-771.  Condensation  of  the  same  article  in  A.  S.  Dewing's  Finan- 
cial Policies  of  Corporations  (1920),  vol.  iv.  pp,  3-RS;  and  A.  S.  Dew- 
ing's  Corporate  Promotions  and  Reorganizations  (1914).  This  book  is 
quite  unusual  in  its  wealth  of  illustrations  of  incompetency  in  industrial 
management. 


ANALYSIS  OF  REPORT  57 

successfully  protects  the  interests  of  its  security  holders,  also 
adopts  the  policy  of  reducing  the  chance  of  losses  to  a  minimum, 
and  compensating  certain  disadvantages  by  other  advantages. 
In  this  connection,  the  difference  in  the  character  of  organiza- 
tion— a  difference  essential  to  each  respective  type  of  corpora- 
tion— must  be  recognized  in  making  any  comparisons. 

Affiliated  and  controlling  interests  frequently  have  given  a 
corporation  the  financial  support  or  the  needed  markets  to  make 
its  success  assured,  even  in  its  formative  period.  Strong  bank- 
ing connections  usually  mean  not  only  an  advantage  in  bor- 
rowing during  normal  times,  but  the  assurance  of  sufficient 
funds  during  the  periods  of  strain  when  funds  are  most  diffi- 
cult to  procure.  Certainty  of  its  financial  situation  will  not 
infrequently  enable  the  corporation  to  engage  in  new  undertak- 
ings that  would  be  impractical  for  it  to  assume  without  this 
assurance.  Affiliation  with  other  corporations,  either  in  owner- 
ship of  stock  or  in  directors,  means  a  permanent  market  for  at 
least  a  part  of  its  products.  The  prohibitions  of  the  Federal 
anti-trust  laws  which  forbid  one  man's  acting  as  director  on 
the  board  of  more  than  one  corporation,  if  he  is  a  banking  di- 
rector, will  make  the  common  representation  in  more  than  one 
company  more  difficult  to  establish.  But  the  fact  that  two  or 
more  corporations  may  have  the  same  directors  need  not  mean 
any  specific  or  direct  benefits  other  than  the  assurance  of  an 
able  directorate. 

Inter-company  and  holding  company  relationships,  as  re- 
ferred to  in  a  number  of  cases  in  subsequent  pages,  must  be 
scrutinized  with  especial  care  to  determine  the  importance  or 
non-importance  of  this  relationship.  A  holding  company,  to 
acquire  control,  may  be  forced  to  finance  to  the  limit  of  all 
the  assets  of  the  subsidiary  companies,  and  the  subsidiaries  may 
already  have  issued  securities  to  the  full  value  of  these  assets. 
Financial  control  may  exist  with  nominal  control  in  the  opera- 
tion of  subsidiary  corporations,  or  vice  versa — a  condition  which 
might  defeat  its  own  purpose. 

Amount,  Form,  Priority,  and  Margin  of  Securities,  as 
Related  to  Property  Values. — It  is  self-evident  that  the  differ- 
ences in  amount,  form,  priority  of  claim,  and  the  margin  of 
assets  and  earnings  will  affect  the  value  of  a  security,  yet  every 


58  INVESTMENT  ANALYSIS 

day  the  banker  must  emphasize  the  relative  importance  of  these 
facts.  The  trite  old  saying,  "What  is  in  a  name?"  was  never 
more  true  than  here.  The  name  "bond"  on  a  security  is  not  a 
guarantee  of  its  soundness.  The  common  stock  of  a  high  grade 
railroad,  for  example,  is  far  more  desirable  than  the  bonds 
on  some  of  the  ill-fated  irrigation  districts  in  Colorado  at  the 
present  time.  Though  the  bonds  of  two  different  companies 
may  have  the  same  legal  claims,  they  cannot  be  put  in  the 
same  class  if  one  company's  bonds  are  secured  with  double  the 
assets  and  earning  power  of  the  other  company.  Neither  can 
securities  on  the  same  company  with  different  priorities,  that  is, 
liens,  be  given  the  same  importance. 

The  value  of  every  security,  after  the  value  of  the  assets 
and  the  earning  power  of  the  corporation  are  established,  must 
be  determined  upon  its  relation  to  the  amount,  form,  priority, 
and  margin  of  security  offered.  It  is  the  almost  unlimited 
variety  of  combinations  of  these  factors  that  makes  the  analysis 
of  each  security  issue  an  individual  problem.  Even  in  the 
same  company  a  small  issue  with  first  priority  in  claims  might 
be  a  very  desirable  holding;  yet  with  a  large  number  of  junior 
issues  outstanding,  the  more  remote  holdings  will  have  little 
value.  These  conditions  must  also  be  applied  with  wide  differ- 
ence in  the  different  types  of  companies.  The  average  indus- 
trial can  never  carry  with  equal  safety  as  large  an  amount  of 
bonds,  for  example,  as  the  public  utilities,  for  a  very  much 
smaller  proportion  of  the  industrial  corporation's  assets  can  be 
carried  as  fixed  assets.  The  later  study  of  the  individual 
classes  of  securities  readily  reveals  these  distinctions  that  must 
be  made. 

The  Balance  Sheet  and  Valuation  of  Assets. — The  balance 
sheet  represents  the  condition  of  the  corporation  upon  a  par- 
ticular date.  It  is  further  a  representation  of  the  assets  and 
liabilities,  and  their  difference,  less  owned  capital,  is  the  net 
worth  of  the  property  to  the  owners.1  As  the  object  of  the 
balance  sheet  is  to  show  the  financial  condition  at  the  end  of  a 


*An  excellent  discussion  of  the  net  worth  of  the  corporation  to  the 
stockholders  (called  net  proprietorship  hy  the  author)  is  that  of  Henry 
Rand  Hatfield,  Modern  Accounting  (1913).  pp.  1-34.  See  also  Roy  B. 
Kester,  Accounting  Theory  and  Practice  (1917),  chapter  iv. 


59 

specified  period,  the  contents  of  these  statements  should  be  con- 
structed with  sufficient  detail  to  disclose  accurately,  the  char- 
acter of  the  assets  and  liabilities.  .  As  the  balance  sheet  reveals 
only  the  condition  of  assets  and  liabilities  at  a  specified  time, 
the  necessity  of  rendering  statements  at  regular  intervals 
requires  no  argument. 

A  large  percentage  of  investors  forget  this  limitation  of  the 
balance  sheet;  and  in  examining  a  statement  eleven  months 
after  the  original  date  of  issue,  they  place  as  much  emphasis 
upon  the  financial  condition  shown  at  this  latter  date,  as  upon 
the  date  of  issue.  Though  the  investor  is  not  interested  in  the 
temporary  shifts  in  the  conditions  of  the  corporation,  he  must 
know  whether  these  temporary  movements  have  any  tendency 
toward  permanent  changes.  An  examination  of  the  last  four 
or  five  balance  sheets  will  usually  give  some  indication  as  to 
what  normal  allowances  should  be  made  in  the  interim.  This 
would  not,  of  course,  be  true  of  a  speculative  security. 

In  the  examination  of  a  company's  balance  sheet,  as  stated 
in  the  introduction,  the  examiner  should  first  make  certain  that 
his  statement  includes  complete  and  full  information.  If  the~" 
corporation  is  a  holding  company,  both  a  consolidated  balance 
sheet  and  a  balance  sheet  of  the  subsidiary  properties  should  be 
examined.  The  demand  for  a  consolidated  statement  cannot 
be  too  strongly  emphasized  and  no  investor  should  ever  give 
any  consideration  in  making  an  analysis  of  a  corporation  to 
any  other  than  a  consolidated  statement.  Where  the  consoli- 
dated balance  sheet,  which  represents  the  complete  combined 
statement  of  both  the  parent  and  subsidiary  companies,  is  of 
sufficient  detail,  it  may  be  adequate.  If  one  or  two  accounts 
need  more  explanation  than  can  be  given  in  the  items  of  a 
consolidated  balance  sheet,  an  explanatory  foot  note  should  be 
demanded.  If  a  supporting  schedule  is  attached  to  the  balance 
sheet,  which  should  practically  always  be  the  case,  such  needed 
explanation  can  be  secured  in  this  schedule.  But  only  after 
the  assurance  that  one  possesses  a  complete  statement,  should 
one  proceed  to  make  a  detailed  analysis  of  the  individual  items. 

Taking  first  the  asset  side  of  the  balance  sheet,  there  are, 
roughly,  the  following  main  divisions:  current  assets,  deferred 


60  INVESTMENT  ANALYSIS 

and  contingent  accounts,  and  property  assets  or  fixed  assets. 
Current  assets  include  all  items  of  short  terms  which  are  used 
up  directly  in  production.  Deferred  accounts  are  the  credits 
made  to  the  company  for  the  prepayment  of  such  accounts  as 
taxes.  The  fixed  assets  include  all  properties  as  land,  buildings, 
and  machinery,  which  are  of  a  permanent  character.  In  the 
discussion  of  the  various  divisions  of  the  balance  sheet,  only 
some  of  the  more  important  items  will  be  used,  as  they  will 
illustrate  the  principles.  The  more  modern  order  of  the  treat- 
ment based  on  the  degree  of  the  liquidation  of  accounts  will  be 
followed  in  the  discussion  of  these  items  rather  than  the  old 
English  method  of  placing  fixed  property  accounts  first  in  the 
balance  sheet. 

Current  accounts  require  more  particular  analysis  in  indus- 
trials. In  most  industrials  they  are  the  most  important  meas- 
ure of  the  company's  weakness  or  strength.  The  most  common 
current  assets  carried  in  the  balance  sheet  are  cash,  inventories, 
accounts  receivable,  and  notes  receivable.  Other  current  assets 
will  usually  be  found  to  be  a  modified  form  of  these  same  items. 
The  commonly  accepted  ratio  of  two  to  one  of  current  assets 
receivable  to  current  liabilities,  can  hardly  be  taken  as  an  abso- 
lute standard.  A  one  and  one-half  ratio  might  be  better  than  a 
three  to  one  if  the  liquidity  of  the  former  company's  accounts 
is  very  much  greater  than  that  of  the  latter.  The  impossibility 
of  establishing  a  common  standard  equally  adapted  to  all  cor- 
porations has  necessitated  a  generally  conservative  rule,  which 
becomes  an  ultra-conservative  rule  in  some  corporations.  While 
the  margin  of  current  assets  over  current  liabilities  must  be 
considerable,  this  amount  should  be  based  upon  the  character 
of  the  accounts  and  the  particular  character  of  the  business.  A 
company  might  be  in  a  very  strong  position,  so  far  as  the 
amount  of  its  receivable  accounts  is  concerned,  but,  if  they 
were  not  convertible  at  the  maturity  of  the  company's  own  cur- 
rent bills,  the  company  would  eventually  be  placed  in  an  em- 
barrassing position,  if  not  receivership.  A  great  many  com- 
panies which  extend  long-time  current  credit  have  experienced 
this  very  difficulty.  Organizations,  on  the  other  hand,  which 
are  not  forced  to  extend  their  current  receivables  beyond  fifteen 


ANALYSIS  OF  REPORT  61 

or  thirty  days,  and  also  are  careful  to  whom  they  extend 
credit,  do  not  often  experience  these  difficulties.  Where  the 
extensions  cover  a  seasonal  period  and  the  products  must  be 
produced  some  months  in  advance  the  company's  own  current 
payables  which  are  carried  for  a  longer  period  may  force  it 
into  the  same  situation.  This  again  resolves  itself  into  the 
question  of  convertibility  of  accounts;  namely*  the  floating  of  a 
long  term  obligation. 

There  are  numerous  ways  by  which  corporations  classed  as 
speculative  concerns  endeavor  to  strengthen  their  cash  position 
just  before  the  issuance  of  the  annual  report,  with  the  pur- 
pose of  making  a  good  showing  in  the  annual  statement.  This 
is  frequently  done  at  a  sacrifice  of  the  corporation's  best  inter- 
est. A  corporation  whose  securities  can  be  classed  as  an  invest- 
ment will,  of  course,  never  follow  this  practice.  If  the  practice 
of  discounting  receivables  is  made,  the  conditions  affecting  these 
discounts  should  be  known.  Though  this  practice  has  been 
viewed  askance  by  reputable  business  men  in  this  country,  there 
will  eventually  be  a  broader  use  of  discounts.  While  there  is 
danger  of  a  company  succumbing  to  inflation,  proper  safeguards 
will  prevent  this  by  requiring  a  given  relationship  of  current 
accounts  to  liabilities  in  each  particular  type  of  business. 

Again,  loans  may  be  made  by  the  holding  company  to  sub- 
sidiaries to  make  up  operating  deficiencies  and  the  loans  carried 
as  current  receivables  in  the  balance  sheet  of  the  holding  com- 
pany. A  similar  advance  may  also  be  extended  to  a  subsidiary 
of  a  subsidiary,  or  from  one  subsidiary  to  another.  These  loans 
in  a  few  instances  have  been  used  for  the  payment  of  the  capital 
stock  of  the  holding  company,  or  for  the  liquidation  of  current 
liabilities  of  the  subsidiary.  If  used  for  the  latter,  to  cover 
operating  deficiencies;  for  example,  it  is  a  danger  signal,  yet  it 
would  never  necessarily  appear  in  any  general  statement  of  a 
holding  company.  Manipulations  of  the  assignment  of  busi- 
ness to  the  various  subsidiaries  will  also  enable  considerable 
losses  to  be  centered  in  some  companies  without  any  indication 
of  it  in  the  holding  company's  general  statement,  and  the  hold- 
ing company  will  still  indicate  strong  earnings,  but  a  detailed 
study  of  this  is  the  function  of  corporation  finance. 


62  INVESTMENT  ANALYSIS 

Inventories  should  be  taken  at  cost,  except  where  the  market 
price  is  lower,  in  which  case  the  latter  should  be  taken.  This  is 
especially  necessary  where  there  are  wide  and  decided  fluctua- 
tions in  the  price  of  raw  materials  or  other  goods  appearing  in 
inventories.  If  the  contrary  practice  of  writing  up  profits  is 
used  with  an  increase  of  the  market  price  of  raw  products, 
paper  profits  are  obtained,  a  condition  which  is  contrary  to 
sound  accounting  principles  and  very  often  leads  to  endless 
confusion.  The  other  consideration  of  inventories,  namely — 
the  stock  on  hand — should  be  governed  by  the  character  of  the 
business,  the  period  of  production,  seasonal  conditions,  short- 
age in  supply,  and  the  character  of  payments.  A  few  years 
ago  a  large  automobile  corporation  purchased  a  large  quantity 
of  material  and  experienced  very  great  difficulty  in  meeting  its 
payables,  as  the  sales  department  failed  to  materialize  on  its 
own  program.  The  corporation  was  consequently  overloaded 
with  both  raw  material  and  finished  cars,  and  a  large  amount  of 
inventories  at  the  close  of  the  season.  Where  the  production 
period  extends  over  several  months,  it  may  be  necessary  before 
the  regular  selling  season  has  ended,  to  purchase  large  quanti- 
ties of  raw  products,  but  the  character  of  the  industry  will 
easily  determine  this  condition.  Lastly,  the  date  upon  which 
the  report  is  rendered  should  be  checked  to  see  whether  it  rep- 
resents an  average  position  for  the  year.  An  abnormal  condi- 
tion either  way  at  the  time  of  the  rendition  of  the  report,  will 
give  an  entirely  false  impression  of  the  company's  normal  con- 
dition during  the  remainder  of  the  year. 

In  valuating  current  assets  of  industrials,  the  distinction 
between  the  greater  stability  of  the  fixed  assets  and  the  con- 
stant change  taking  place  in  current  assets,  is  apparent.  Cur- 
rent assets,  even  where  they  form  an  unimportant  part  of  the 
total  assets,  are  quickly  turned.  If  for  no  other  reason,  an 
extraordinarily  large  amount  tied  up  in  inventories  means  the 
cutting  down  of  profits  by  an  idle  investment  in  these  items. 
In  extraordinary  times,  an  advantage  may  exist  in  buying  at 
lower  prices,  but  not  over  very  long  periods.  The  possible  in- 
numerable changes  that  may  affect  current  assets  demand  an 
ultra-conservative  valuation  in  contrast  with  well-maintained 
fixed  property  accounts. 


ANALYSIS  OF  REPORT  63 

The  deferred  accounts  upon  the  asset  side  of  the  balance 
sheet  are  usually  of  minor  importance.  Accruals  of  interest 
and  rents  and  advances  to  employees  need  be  considered  only 
where  the  advances  are  above  the  normal  amount  which  should 
be  carried  by  the  corporation.  While  some  one  has  termed  some 
of  the  deferred  assets,  "assets  by  courtesy,"  the  practice  of 
considering  these  advances  where  made  to  the  benefit  of  the 
corporation  is  legitimate,  but  they  should  be  written  off  as  the 
periods  expire.  Granting  the  legitimacy  of  the  accounts,  the 
only  check  necessary  is  the  correct  distribution  of  the  amount 
for  the  periods  used. 

In  the  third  main  division  of  assets,  namely :  fixed  assets,  the 
first  thing  which  is  likely  often  to  cause  serious  differences,  is 
the  lack  of  uniformity  in  valuating  these  assets.  Even  where 
an  actual  physical  appraisal  is  made,  the  difference  between 
engineers'  estimates  adds  to  the  difficulties  of  the  accountant. 
With  sufficient  allowances  for  these  differences,  the  appraisal 
of  a  property  will  give  the  most  accurate  basis  for  judgment. 
In  considering  the  equity  behind  his  bond  the  investor  is  pri- 
marily interested  in  the  corporation  as  a  going  concern, 
although  he  cannot  disregard  liquidation  value,  that  is,  the  sale 
price  in  foreclosure,  or  what  method  of  valuation  will  be  used 
as  a  basis  for  rates  or  tax  purposes.  If  the  conservative  method 
is  followed  in  valuating  the  company  assets,  i.  e.,  valuating  it 
as  a  going  concern,  margins  sufficient  for  all  practical  purposes 
will  be  allowed  to  protect  the  fixed  property  account  against 
changes  of  valuation  made  by  any  commission. 

Of  the  fixed  property  accounts,  land  is  generally  the  least 
changeable  in  character  for  the  purpose  for  which  it  is  used. 
The  conservative  practice  is  to  carry  this  land  at  its  original 
cost.  Some  companies  follow  the  doubtful  practice  of  writing 
up  the  assets  of  a  company  where  the  land  increases  in  value. 
While  on  the  face  of  it,  this  may  seem  justified,  the  writing  up 
of  an  asset  means  the  arbitrary  creation  of  a  profit.  It  makes 
the  statements  of  the  company  misleading,  as  a  statement  of 
profits  should  consider  only  the  actual  returns  from  the  current 
revenue  of  the  corporation ;  otherwise  a  paper  profit  has  been 
created.  Where  land  depreciates  in  value,  the  amount  of  this 
depreciation  should  be  written  off  out  of  current  earnings 


64    ,  INVESTMENT  ANALYSIS 

in  order  to  maintain  the  fixed  property  equity  back  of  its 
security. 

Where  the  land  is  held  by  railroads,  street-railways,  and 
other  public  utilities,  the  evaluation  of  land  is  not  such  a  simple 
matter.  In  the  first  case,  contrary  to  popular  opinion,  the 
terminal  properties  in  the  city  which  probably  constitute  on  the 
average  more  than  75  per  cent  of  the  land  value  owned  by  the 
railroad,  have  been  bought  at  varying  times  and  at  prices  much 
higher  than  adjoining  land.  It  is  extremely  difficult  to  deter- 
mine what  these  costs  should  be,  and  what  allowances  should  be 
made  for  the  right  of  way  which  the  street-railway  only  has  the 
privilege  to  uso  for  a  term  of  years.  These  problems  are  dis- 
cussed at  great  length  in  subsequent  chapters. 

Buildings,  and  other  fixed  property  accounts  as  ties,  rails, 
cars,  gas  mains,  electric  and  telephone  wires,  etc.,  should  be 
carried  at  cost,  less  depreciation.  All  additions  to  these 
accounts  should  be  added  to  the  total  cost  of  the  property,  and 
conservative  practice  demands  that  no  replacement  costs  be 
considered  in  these  totals.  According  to  the  rulings  of  the 
Interstate  Commerce  Commission,  where  a  railroad  constructs 
a  building  on  a  new  site  and  then  abandons  its  old  building, 
the  original  cost  of  the  latter  should  be  deducted  from  the  cost 
of  the  new  plant,  to  obtain  the  value  at  which  the  new  plant 
should  be  carried  (less  the  depreciation  carried). 

"While  the  amount  for  depreciation  must  be  determined  in 
each  particular  instance  according  to  the  business  of  the  cor- 
poration, sound  financing  no  longer  questions  its  necessity. 
Such  allowance  should  be  annually  set  aside  to  cover  the  replace- 
ment when  required.  Of  the  methods  most  commonly  used 
one  is  to  retain  the  assets  at  their  original  value  in  the  accounts 
and  to  set  up  a  reserve  lor  depreciation  on  the  liability  side  out 
of  earnings.  The  other  is  to  charge  off  earnings  against  the 
property  assets  and  show  a  reduced  value  each  year.  Thus  the 
property  account  would  show  &  decline  each  year.  The  former 
has  the  advantage  of  showing  at  all  times  the  total  investment 
in  these  assets  that  has  been  made  as  well  as  the  total  reserves 
for  depreciation. 

Accounting  history  is  replete  with  the  failures  of  corpora- 


ANALYSIS  OF  REPORT  65 

tions  which  have  deferred  making  allowances  for  this  fund. 
The  ruling  of  the  Supreme  Court  in  the  Knoxville  v.  Knoxville 
Water  Company,  was  an  unequivocal  acceptance  of  depreciation 
deductions.  The  court  held  that,  even  though  the  water  com- 
pany  had  failed  to  make  provision  for  depreciation  in  the  past, 
the  company  could  not  value  the  property  at  reproduction  costs 
without  deducting  the  allowance  for  depreciation.  The  forced 
recognition  of  depreciation  is  not  now  apt  to  be  necessary 
because  of  the  advantage  in  allowing  its  deduction  for  the 
income  tax. 

Irregular  depreciation  allowances  should  usually  be  viewed 
askance.  This  practice  nearly  always  denotes  an  attempt  to 
bolster  up  net  profits.  One  of  the  more  important  things  in 
the  unfortunate  experiences  of  the  Metropolitan  Street  Railway 
system  of  New  York  City  was  its  disregard  of  depreciation 
requirements.  Where  the  allowance  is  made  according  to  pro- 
duction, considerable  difference  will  be  found  between  the  "lean 
and  fat  years,"  but  this  is  an  irregular  sum  due  to  the  method 
and  is  not  the  same  as  an  irregular  allowance  regulated  by  the 
annual  choice  of  the  directors.  The  former  is  based  on  a  sound 
policy  of  allowing  a  proportionate  amount  for  deterioration ; 
the  latter  is  practically  always  an  attempt  to  make  a  good  show- 
ing in  net  profits.1  In  speculative  issues,  the  latter  has  been 
used  for  the  manipulating  of  stock  prices  and  in  some  instances 
this  policy  has  been  directed  by  the  underwriters  to  protect 
their  own  interests.  Unless  a  rigid  policy  is  adhered  to  by  a 
corporation,  depreciation  is  the  easiest  to  omit,  when  pressure 
upon  the  demands  of  the  corporation  is  heavy.  No  doubt,  there 
may  be  at  considerable  intervals,  an  occasional  year  when  a 
deferment  of  the  charge  could  be  made  under  such  pressure, 
but  the  reason  for  it  should  be  frankly  stated.  It  can  be  safely 
said  that  all  corporations  whose  securities  are  to  be  classed  as 
investments  must  make  adequate  provision  for  depreciation. 

The  same  procedure  should  govern  the  estimates  of  valuing 


'For  interesting  references  in  railroad  surplus  accounts,  see  Homer 
Bews  Yanderblue's  Railroad,  Valuation,  pp.  115-117  and  171-173;  see  also 
Eastern  Advance  Case  of  1910.  20  7.  C.  C'.,  pp.  43  and  271 ;  Spokane  v. 
N.  T.  Ry.  Co.,  15,  7.  C.  C.  376,  410  and  415. 


66  INVESTMENT  ANALYSIS 

machinery  and  tool  accounts,  as  is  used  in  the  case  of  buildings, 
except  that  the  former  are  much  shorter-lived.  The  same  is 
true  of  furniture  and  fixtures,  which  are  usually  a  very  unim- 
portant item  in  the  total  amount.  Patterns,  plates,  copyrights, 
patents,  and  kindred  items  are  very  difficult  to  appraise.  The 
character  of  these  items,  as  with  good-will  can  be  so  easily 
increased  to  offset  either  over-capitalization  or  losses  from  bad 
management,  that  they  demand  the  closest  scrutiny  as  to  their 
validity.  Patterns  and  copyrights  which  have  been  allowed 
to  accumulate  for  years  at  their  full  value,  and  can  never  be 
used  again,  will,  in  the  majority  of  cases,  eventually  place  the 
company  in  a  very  weak  position.  Swollen  patent  accounts 
have  had  the  same  experience.  On  the  other  hand,  there  are 
patents  which  have  been  worth  millions.  The  best  method  of 
checking  the  value  of  the  accounts  representing  good  will  is  to 
capitalize  the  income  which  actually  represents  income  derived 
from  possessing  these  rights.  Conservative  practice,  however, 
usually  demands  that  patents  be  written  off  long  before  the 
expiration  of  their  legal  rights.  If  for  no  other  reason  than 
the  fact  that  the  market  discounts  a  condition  of  this  sort  long 
in  advance,  this  should  be  done. 

There  is  no  standard  established  for  the  use  of  good-will. 
As  in  the  case  of  other  intangible  accounts,  the  choice  depends 
upon  the  desire  of  the  management.  In  all  cases  the  item  of 
good- will  should  be  separated  from  the  fixed  property  account. 
Too  frequently  it  is  not,  and  in  corporations  where  this  is  true, 
an  accurate  analysis  of  the  property  cannot  be  made. 

The  justification  for  the  existence  of  a  good-will  account  is 
made  on  the  basis  of  the  surplus  that  has  accumulated  out  of 
earnings,  which  shows  both  the  past  earning  capacity  of  the 
business,  and  the  existing  earning  power  of  the  business.  The 
most  prevalent  English  custom  in  the  sale  of  business  has  been 
the  valuation  of  good-will  upon  the  basis  of  the  net  profits  from 
two  to  ten  years  in  the  future,  the  capitalization  rate  depending 
upon  the  stability  of  the  income  of  the  business.  It  is  doubtful 
if  good-will  should  ever  be  considered  as  anything  else  than  a 
direct  appraisement  of  that  part  of  the  earning  power  of  a 
company  which  cannot  be  attributed  to  the  other  assets  of  the 


ANALYSIS  OF  REPORT  67 

company.1  This  method  of  capitalization  of  good-will  does  not 
allow  for  the  valuation  of  good-will  of  the  company  under  a 
particular  person  or  management,  but  provides  for  it  at  the 
rate  which  would  apply  to  it,  under  any  management  as  a  going 
concern.  While  the  importance  of  management  has  been 
strongly  emphasized,  the  valuation  of  good-will  should  be  made 
as  an  impersonal  and  not  a  personal  matter,  if  good-will  is  to 
be  given  value  of  a  permanent  character. 

Though  the  franchise  is  quite  similar  in  most  aspects  to  good- 
will, there  are  two  important  differences  to  be  considered :  first, 
that  it  is  under  government  regulation;  and  second,  that  the 
right  to  this  franchise  expires  at  a  given  time.  This  latter 
condition  makes  it  imperative  that  the  franchise  should  be 
amortized  during  the  period  of  its  existence.  The  present 
value  on  the  basis  of  the  original  value  assumed,  can  be 
easily  ascertained  by  the  amount  of  amortization.  After  a 
period  of  years,  it  is  also  possible  to  determine  whether  the  orig- 
inal valuation  placed  upon  the  franchise  is  too  great  for  the 
earnings  of  the  company.  In  a  new  company  or  a  new  consoli- 
dation, this  is,  of  course,  impossible.  There  seems  to  be  a  ten- 
dency among  conservatives,  at  present,  to  allow  no  issue  of  stocks 
or  bonds  for  the  franchise  value,  as  in  the  case  of  Massachusetts, 
but  the  tendency  is  not  strong  enough  to  warrant  definite  asser- 
tion, and  the  ease  with  which  the  weather-vane  of  political  opin- 
ion is  shifted  makes  prophecies  uncertain.  But  it  is  not  necessary 
to  consider  the  ethics  of  allowing  a  franchise  value.  The  analyst 
is  concerned  only  with  what  conditions  are,  and  whether  values 
in  property  and  earning  power  allowed  are  sufficient  to  cover 
the  security  under  question. 

The  items  of  investments  can  normally  be  considered  a  semi- 
fixed investment,  though  there  are  companies  whose  items  may 
be  placed  in  the  classification  of  fixed  holdings  and  others  in 
current  accounts,  depending  upon  the  purpose  for  which  they 
are  carried.  In  either  case,  the  item  of  investments  should  be 
considered  separately  from  either  of  these  two  general  classes 
of  accounts,  and  their  valuation  should  be  determined  according 
to  the  regular  method  of  ascertaining  values.  A  sharp  distinc- 


1William  H.  Lough,  Business  Finance  (1917),  pp.  195-19G. 


68  INVESTMENT  ANALYSIS 

tion  should  also  be  made  between  the  investments  of  stocks  in  a 
company's  own  subsidiary  companies  (not  treasury  stock)  and 
the  investment  in  securities  of  other  companies. 

Very  frequently  the  investments  consist  of  the  stocks  and 
bonds  of  a  company's  own  subsidiaries.  The  value  of  this  item 
as  far  as  the  investor  is  concerned  is  then  determined  by  the 
value  of  the  company  itself,  i.  e.,  its  earning  power.  Where 
these  holdings  are  of  a  company's  own  securities,  they  do  not 
represent  the  same  "risk"  value  to  the  company  as  the  hold- 
ings of  equal  security  outside  of  the  company.  In  the  latter, 
there  is  greater  insurance  against  risk.  Even  where  a  general 
depression  exists,  the  security  of  an  entirely  different  company 
is  not  apt  to  be  affected  to  the  same  extent  as  a  company's  own 
stock. 

These  securities  of  a  holding  company's  own  subsidiaries 
should  be  carried  at  cost.  A  reserve,  however,  should  be  set  up 
if  any  depreciation  occurs  below  the  price  at  which  these  secu- 
rities are  carried.  In  speculative  companies,  the  actual  market 
price  of  the  security  will  often  fall  under  par,  a  condition  which 
will  indicate  greater  weakness  in  the  parent  company  than  the 
market  price  of  its  own  securities  indicates,  especiaUy  wrhere  it 
is  a  holding  company.  Where  the  entire  amount  of  the  capital 
stock  of  a  subsidiary  is  held,  there  is  no  basis  upon  which  to 
judge  from  the  market  standpoint,  but  the  analysis  of  the  sub- 
sidiary should  show  the  worth  of  these  securities.  So  much  jug- 
gling has  been  carried  on  under  the  guise  of  this  account  by 
holding  companies  that  the  account  should  never  be  accepted 
at  its  face  value  until  tested.1 

When  securities  have  been  purchased  for  a  sinking  fund  of 
the  company,  they  are  usually  carried  under  this  name.  These 
funds  are  accumulations  set  aside  to  meet  maturing  obligations. 
This  fund  may  be  put  in  cash  either  in  the  hands  of  a  trustee 
or  the  company's  treasury,  or  the  funds  may  be  invested  in  the 
company's  own  securities  or  those  of  another  company.  If  this 
fund  is  carried  in  the  company's  own  treasury,  especially,  if 
it  is  in  cash,  it  always  proves  to  be  a  temptation  to  the 


JSee  early  experiences  of  Westinghouse  Electric  and  Manufacturing 
Company. 


ANALYSIS  OF  REPORT  69 

officials  if  the  company  gets  into  financial  straits.  There  is 
grave  danger  in  this,  as  was  experienced  in  the  great  period 
of  railroad  receivership  of  the  nineties.  Many  investors 
awakened  to  find  that  the  sinking  fund  was  a  pure  bookkeeping 
fiction,  and  that  the  funds  had  been  placed  into  properties  which 
had  also  been  dissipated  in  a  failing  company.  Where  the  fund 
is  turned  over  to  a  trustee,  there  is  no  question  of  the  safety  of 
the  fund,  but  there  is  of  a  low  rate  of  return.  That  is,  a  bond's 
own  rate  may  be  6  per  cent,  while  the  trustee  allows  less  than 
4  per  cent.  The  same  criticism  also  can  be  often  made  of  invest- 
ment in  the  high-grade  securities  of  other  companies.  The  sim- 
plest, and  most  profitable  procedure — a  procedure  of  equal  value, 
both  from  the  standpoint  of.  the  rate  of  return  and  the  increased 
value  of  the  equity — is  the  purchase  of  a  company's  own  bonds 
for  the  sinking  fund.  The  burden  is  equally  distributed,  no 
chance  of  a  bad  investment  exists,  and  the  return  is  maintained. 

If  a  leasehold  has  been  bought,  the  value  of  the  leasehold 
should  be  capitalized  upon  the  rental  value  of  the  lease,  and  its 
entire  value  written  off  over  the  life  of  the  lease. 

Care  should  be  taken  in  regard  to  all  property  as  well  as 
inventories  that  ample  insurance  is  carried  at  all  times.  Con- 
cerns which  carry  large  stocks  of  inventories  which  are  con- 
stantly changing  from  day  to  day  must  make  almost  daily 
adjustment  of  their  insurance  accounts.  Where  the  plants  are 
widely  scattered,  as  in  the  Woolworth  stores,  it  is  cheaper  for 
the  company  to  carry  its  own  insurance,  because  of  the  wide  dis- 
tribution of  the  risk.  The  amount  carried  on  properties  is,  how- 
ever, usually  under  the  amount  of  insurance  that  should  be 
carried. 

On  the  liability  side  of  the  balance  sheet,  the  four  general 
and  common  classifications  are:  current  accounts  or  liabilities, 
accrued  accounts,  reserve  accounts,  and  fixed  liabilities.  While 
all  of  these  accounts  from  the  standpoint  of  the  corporation 
must  strictly  be  termed  liabilities — from  the  standpoint  of  the 
owners  or  stockholders  they  cannot  so  be  classed.  The  reason 
for  this  will  appear  as  the  individual  items  are  discussed. 

The  current  liabilities  wJiich  commonly  include  accounts 
payable  and  notes,  drafts,  acceptances  and  bills  payable  are 


70  INVESTMENT  ANALYSIS 

unfunded  obligations  of  the  corporation.  The  first  of  these 
accounts  should  always  be  separated  from  the  last  three 
accounts.  The  former  are  the  open  book  accounts.  They  may 
vary  according  to  the  requirements  of  the  particular  business, 
the  season  of  the  year,  the  turnover,  period  of  manufacture  and 
the  date  on  which  the  balance  sheet  is  rendered. 

Bills  and  notes  payable  are  alternately  used.  When  both 
items  are  used  in  the  same  statement  bills  payable  often  include 
drafts  payable  and  acceptances.  When  funds  are  needed  for 
seasonable  purposes  and  purchases  must  be  made  in  advance,  or 
the  firm  takes  advantage  of  cash  discounts,  etc.,  or  over  due 
payments,  this  form  of  formal  obligation  is  commonly  assumed. 
These  obligations  ordinarily  range  for  10,  15,  30,  60,  90  days 
and  six  months.  The  ratio  of  the  amount  of  current  liabilities 
to  current  assets  and  the  ability  of  the  corporation  out  of  cur- 
rent assets  to  meet  its  current  payables  as  they  come  due  must 
always  be  carefully  checked.  The  ability  particularly  of  indus- 
trial corporations  to  keep  the  current  assets  sufficiently  liquid 
to  meet  the  current  liabilities  together  with  the  avoidance  in 
overloading  with  current  payables  in  periods  of  strain,  will  prac- 
tically always  give  evidence  of  the  company's  strength. 

Accrued  accounts  represent  the  amounts  accrued  from  the 
date  of  the  last  payment,  but  not  yet  due.  For  example:  the 
last  interest  paid  was  on  January  1st  and  the  next  payment 
is  not  due  until  six  months  later,  a  statement  then  rendered 
April  1st  would  show  the  proportionate  amount  of  interest  up 
to  this  latter  date.  The  same  would  be  true  of  such  accounts  as 
taxes,  payrolls,  rents,  insurance,  dividends,  etc.  Some  corpora- 
tions include  all  accrued  accounts  as  a  part  of  the  current 
liabilities  discussed. 

No  balance  sheet  can  set  forth  a  correct  statement  of  a  cor- 
poration's financial  position,  unless  complete  provisions  have 
been  made  for  reserves.1  Corporate  executives  are  now  gen- 
erally agreed  that  these  allowances  must  be  made.  Otherwise  in- 


JFor  a  detailed  discussion  of  depreciation  and  reserves  see :  Roy  B. 
Kester,  Accounting  Theory  and  Practice,  vol.  ii  (1920),  pp.  120-209; 
Paul-Joseph  Esquerre,  The  Applied  Theory  of  Accounts  (1917),  pp.  369- 
383 ;  Arthur  Lowes  Dickinson,  Accounting  Practice  and  Procedure 
(1914),  pp.  145-174;  and  Robert  H.  Montgomery,  Auditing  Theory  and 
Practice  (1919),  pp.  129-145,  181-185. 


ANALYSIS  OF  REPORT  71 

roads  are  made  on  the  capital  investment  of  the  company. 
Where  the  individual  accounts  are  adequately  set  forth,  it  is  an 
easy  matter  with  comparative  balance  sheets  to  determine 
whether  the  allowances  for  these  reserves  are  adequate.  Among 
the  requirements  for  which  these  reserves  and  allowances  should 
be  set  aside  are :  depreciation  of  plant,  exhaustion  of  minerals, 
discounts,  bad  debts,  reduction  in  value  of  goods,  special  bene- 
fits, special  contingencies,  sinking  funds  for  the  retirement  of 
bonds  and  preferred  stock  provisions  against  future  interest, 
dividends,  special  expenditures,  taxes  and  other  future  outlays 
chargeable  against  the  current  income. 

The  older  practice  in  providing  for  all  depreciation  funds 
and  future  allowances  was  to  create  a  reserve  account  liability. 
The  more  modern  practice,  but  not  yet  widely  adopted,  is  to  dif- 
ferentiate between  depreciation  allowed  against  wasting  assets 
and  the  reserves  voluntarily  set  up  to  provide  for  future  out- 
lays.   The  former,  for  example,  is  illustrated  in  the  depreciation 
of  the  fixed  property  account  of  a  corporation.     Instead  of  cre- 
ating a  property  depreciation  reserve  as  a  liability,  the  amount 
of  the  depreciation  reserve   immediately  follows  the  wasting 
asset  account.     As  Kester  states:  "The  depreciation  reserve  is 
as  much  a  part  of  the  record  of  the  asset  as  the  asset  account 
itself.     The   two  accounts  are  complementary,  neither  giving 
reliable  information  without  the  other.     The  reserve  account  is 
thus  always  and  only  a  balance  sheet  account."       From  the 
standpoint  of  the  financial  analyst,  this  method  of  treatment  by 
the  accountant  gives  the  immediate  and  complete  information 
wanted  without  the  necessity  of  further  calculation.     These  are : 
(1)  the  original  value  of  the  property  in  the  original  valuation 
figures;2  (2)  the  amount  of  the  depreciation  allowed  up  to  the 
time  of  the  issue  of  the  report;  and  (3)  the  net  value  of  the 
property  under  consideration.     The  same  method  of  treatment 
is  applicable  to  such  deduction  as  must  be  made  from  receiv- 
ables, for  bad  debts  and  from  inventories  for  the  existing  value 
of  the  stock  on  hand,  etc. 

'Roy  B.  Kester,  Accounting  Theory  and  Practice,  vol.  ii  (1920), 
p.  187. 

2While  some  corporations  carried  forward  only  the  net  valuation 
figures,  there  can  be  little  question  as  to  the  continuation  of  the  original 
valuation. 


72  INVESTMENT  ANALYSIS 

Again  looking  at  such  items  as  Federal  taxes,  interest,  etc., 
from  the  point  of  view  of  financial  analysis,  it  is  obvious  that 
the  old  method  of  a  specific  reserve  created  as  a  liabilty  of  the 
corporation  is  necessary.  These  allowances  are  for  a  liability 
coming  due  and  created  against  the  company  at  a  future  date. 
This  kind  of  an  allowance  is  contrary  to  the  principle  under- 
lying depreciation,  namely,  the  allowance  (depreciation)  for  the 
replacement  of  property  possessed.  While  this  distinction  may 
not  always  seem  essential  for  purely  accounting  purposes,  it  is 
evident  that  the  distinction  must  be  made  in  any  financial 
analysis. 

A  good  deal  of  criticism  has  been  aimed  at  the  so-called 
secret  reserves  which  may  be  created  by  such  methods  as  the 
undervaluing  of  property  and  inventory  accounts,  etc.,  or  sur- 
charging depreciation,  allowances,  reserves,  betterment 
accounts,  etc.  No  specific  account,  of  course,  appears  in  any 
of  these  instances.  Many  other  methods  are  employed  which 
might  be  suggested,  but  in  each  case  the  purpose  is  to  have  a 
larger  net  value  than  is  revealed  in  the  accounts.  The  defense 
used  for  such  practices  is  that  it  gives  an  ultra-conservative 
value  of  properties.  While  this  must  be  granted,  accounts 
which  do  not  reveal  the  complete  condition  of  affairs  must 
always  be  open  to  question.  No  one  presumably  but  the  officials 
and  probably  the  directors  can  know  of  the  true  status  of  the 
corporation.  This  in  itself  is  sufficient  to  subject  this  practice 
to  criticism.  Though  the  Federal  Income  Tax  Law  and  rulings 
are  supposed  to  prevent  and  correct  over-allowances  of  this 
character  it  is  questionable  whether  it  is  within  the  possibility 
of  this  bureau  to  check  all  violations. 

Fixed  liabilities  are  divided  into  two  groups:  creditors 
claims  and  proprietorship  claims.  Under  the  creditors'  claims 
are  grouped  bonds,  notes  and  mortgages,  which  are  distin- 
guished from  the  current  obligation  by  specific  liens,  priority  in 
rights,  greater  formality  in  the  issuance  of  the  claims,  and 
longer  duration.  The  board  of  directors,  under  the  specified 
limitations  of  the  charter  of  their  own  company,  and  in  most 
states  by  statutes,  are  privileged  to  make  an  authorization  of 
securities,  though  these  may  not  all  be  sold.  The  authorized 


ANALYSIS  OF  REPORT  73 

amount,  the  amount  outstanding,  and  the  amounts  held  in  the 
sinking  fund  and  the  treasury,  as  assets,  should  be  separately 
indicated.  It  is  a  very  common  practice  not  to  do  this.  If  a 
large  authorization  has  been  made  and  only  the  outstanding 
issue  entered,  and  if  the  directors,  within  a  year  after  a  pur- 
chase of  a  security,  decided  to  increase  the  amount  of  the 
issue  outstanding,  a  very  material  depression  in  the  price  of 
the  security  held  would  result.  When  the  margin  back  of 
either  a  fixed  charge  or  a  dividend  is  lowered — and  this  would 
be  at  least  the  immediate  result  of  an  increase  in  the 
amount  of  securities — the  safety  of  the  income  is  more  than  cor- 
respondingly decreased.  The  exact  ratio  depends  upon  the 
type  of  organization,  the  rate  increasing  at  a  more  rapid  pro- 
gression with  the  increase  in  the  speculative  character  of  the 
business.  A  complete  title  of  the  bond  or  mortgage  should  also 
be  given,  though  the  title  of  the  instrument  on  the  balance  sheet 
should  never  be  accepted  as  a  complete  statement  cf  the  lien 
and  priority  in  claims  of  a  particular  security. 

The  proprietorship  claims,  the  second  general  division  of 
fixed  liabilities,  are  represented  in  capital  stock,  surplus,  and 
undivided  profits.     The  authorization  and  limitation  of  capital 
stock  issues  are  restricted  by  the  same  authorities  as  bond  issues, 
and  what  has  been  said  concerning  authorized  and  outstanding 
issues  can  be  applied  to  the  different  types  of  stocks.    Confusion 
as  to  what  constitutes  outstanding  stock  is  more  prevalent  than 
with  bonds,  and  this  matter  needs  particular  emphasis.    Author- 
ized capital  stock  which  has  never  been  issued,  is  frequently 
called  treasury  stock,  which  is  entirely  erroneous.     Treasury 
stock  is  a  company's  own  stock  that  has  been  issued  and  brought 
back  into  the  treasury:  (1)  through  purchase  by  the  company 
itself;  (2)  or  through  a  gift;  (3)  or  taken  back  for  bad  debts. 
Treasury  stock  is  always  carried  as  an  asset  or  deducted  from 
the  capital  stock  outstanding  and  has  the  right  to  be  re-issued. 
It  has  no  right  to  dividends  or  to  vote.    Its  right  of  re-issue,  no 
doubt,  has  been  responsible  for  its  confusion  with  the  right  of 
unissued   stock  which   also  has  the  right  to  be  issued.     Un- 
issued stock  is  neither  an  assej;  nor  a  liability,  and  has  the  single 
right  of  issuance  when  authorized  by  the  directors.     Neither 


74  INVESTMENT  ANALYSIS 

must  treasury  stock  be  confused  with  the  stock  of  subsidiary 
companies  which  is  carried  as  an  asset  in  the  balance  sheet  of  a 
holding  company.  In  most  states,  newly  issued  stock  must  bear 
full  liability,  while  treasury  stock  is  liable  only  to  the  amount 
for  which  it  is  sold.1  The  better  practice  is  to  deduct  it  from 
capital  stock.  Where  the  amounts  of  these  deductions  are  small, 
it  is  of  little  consequence.  Where  it  is  of  large  amount,  the 
reason  for  its  existence  should  be  known. 

In  new  companies,  or  in  the  refinancing  of  companies,  the 
stock  issue  is  frequently  over-capitalized  on  the  theory  that  the 
development  of  the  company  through  this  new  capital  will  in- 
crease the  surplus  and  earnings  of  the  company  to  a  sufficient 
extent  to  warrant  this  over-capitalization.  A  strong  company 
with  an  unquestionable  future  in  earning  power  may  do  this, 
It,  however,  makes  this  a  speculative  and  not  an  investment  pur- 
chase, so  far  as  the  stocks  are  concerned.  With  an  examina- 
tion of  the  methods  of  valuation  of  assets,  over-valuation  can 
usually  be  determined. 

A  very  common  guide  used  by  some  investors  is  to  take  the 
book  value2  of  the  shares  of  stock.  The  fact,  however,  that  a 
company  shows  a  book  value  of  $150  or  $200  a  share  may  have 
no  significance.  The  surplus  which  represents  the  net  balances 
may  have  been  invested  in  property  which  is  still  carried  at  full 
value,  though  it  has  undergone  serious  deterioration.  A  com- 
pany on  the  verge  of  bankruptcy  might  show  a  respectable  book 
value.  The  actual  worth,  as  with  every  item,  depends  on  the 
surplus  account  which  appears  in  the  corporation  statement  and 
is  commonly  thought  to  be  derived  from  earnings.  While  this 
is  most  frequently  the  case  it  is  not  necessarily  true.  Surplus 
accounts  should  be  divided  into  profit  and  loss  surplus  and 
capital  surplus.  The  former  is  accumulated  out  of  earnings  of 

JThere  are  exceptions  to  this  general  rule,  which  can  easily  be 
found  in  such  a  standard  work  as  Arthur  Webster  Machen's  Corpora- 
tions (1908).  The  statutes  of  some  states  prohibit  a  corporation  from 
dealing  in  its  own  stock. 

2The  total  book  value  is  found  by  dividing  the  capital  stock  and 
surplus  and  appropriated  reserves  by  the  capital  stock.  To  find  the  book 
value  of  one  share,  divide  the  total  book  value  by  the  number  of  shares. 
If  more  than  one  class  of  stock  is  outstanding,  the  various  stock  must 
be  given  full  preference  in  the  order  of  their  priority. 


ANALYSIS  OF  REPORT  75 

the  business.  The  latter  may  be  secured  from  several  sources, 
such  as:  (1)  the  sale  of  assets  above  their  book  value;  (2)  in- 
creasing the  price  at  which  the  assets  are  carried  by  a  revalua- 
tion of  assets;  (3)  by  the  sale  of  the  securities  at  a  premium.  It 
is  obvious  that  the  sources  of  these  funds  are  so  different  and 
their  significance  to  the  corporation  so  distinct,  that  no  argu- 
ment need  be  advanced  for  their  absolute  separation. 

Some  corporations  divide  the  surplus,  profit  and  loss,  de- 
rived from  earnings  into  two  classes,  namely,  the  surplus  which 
is  to  continue  permanently  and  the  undivided  profit  account. 
The  latter  amount  is  separated  because  it  is  intended  to  be  only 
a  temporary  fund.  It  is  usually  held  for  the  purposes  of 
annual  expenditures  and  emergencies,  or  for  the  eventual  pay- 
ing out  in  dividends.  Banks  are  more  consistent  in  their  prac- 
tice of  making  this  distinction  between  surplus  and  undivided 
profits.  Corporations  have  not  deemed  it  essential.  It  does, 
however,  have  the  advantage  to  the  outsider  of  giving  more  spe- 
cific information  as  to  the  immediate  purpose  of  the  corporation. 

The  conservative  practice  in  building  up  of  surplus  is  to 
take  it  out  of  current  earnings.  If  the  company  also  follows 
the  policy  of  writing  off  its  doubtful  accounts  and  depreciating 
assets,  surplus  accumulated  out  of  earnings  can  be  taken  as  an 
accurate  measure  of  the  solidity  of  the  business.  The  pursuit 
of  this  policy  also  makes  it  possible  for  the  company  to  secure 
outside  funds  at  a  greater  advantage.  The  extent  to  which 
surplus  can  properly  be  accumulated  out  of  earnings  depends 
upon  the  character  of  the  company.  Where  risks  are  great,  a 
large  surplus  must  be  maintained,  to  insure  normal  safety. 
If  the  amount  maintained  is  large,  it  also  assures  the  continua- 
tion of  regular  dividends.  About  the  only  rule  that  can  be  laid 
down  is  a  general  one.  The  amount  must  be  determined  by  the 
degree  of  fluctuation  and  risk  of  the  business.  The  policy 
adopted  also  depends  upon  the  extent  to  which  the  expansion 
of  the  company  can  be  carried;  if  the  corporation  is  not  justi- 
fied in  turning  increasing  profits  back  into  the  property,  a 
larger  proportion  of  the  profits  had  better  be  distributed  in 
dividends.  This  is  especially,  apt  to  be  the  corporation 's  situa- 
tion, where  its  expansion  is  limited.  The  opposite  policy  of 


76  INVESTMENT  ANALYSIS 

carrying  a  so-called  secret  reserve  is  almost  equally  objection- 
able, as  it  deceives  the  stockholder — concerning  the  real  value 
of  his  holding.  The  secret  reserve  is  maintained  by  placing  in 
the  special  reserve  funds  a  larger  amount  than  is  justified,  or  by 
the  drastic  writing  off  of  asset  accounts.  There  is  one  of  two 
purposes  in  doing  this:  either  the  inside  interests  desire  to 
secure  the  stock,  or  the  desire  is  to  be  able  to  revalue  assets  at 
some  future  time,  if  the  necessity  arises. 

A  great  many  investors  assume  that  because  a  company  has 
a  large  surplus,  granting  it  has  been  accumulated  out  of  earn- 
ings, it  is  in  a  strong  position.  Others,  strange  to  say,  assume 
that  a  surplus  fund  should  mean  an  equivalent  in  securities 
or  cash.  Though  the  surplus  account  must  have  an  equivalent 
offset  in  the  asset  side  of  the  balance  sheet,  there  are  no  "ear- 
marked accounts"  that  are  placed  against  it.  The  corporation 
management  may  place  this  into  any  account  that  it  desires.  If 
the  corporation  has  had  a  number  of  years  of  prosperity,  and 
then  has  serious  reverses,  the  value  of  the  surplus  is  equal  to 
the  value  of  the  depreciated  properties.  Surplus  should  always 
be  considered  in  the  same  light  as  the  investment  of  capital 
stock  and  as  a  proprietorship  account.  Even  where  the  surplus 
accumulations  are  put  into  a  special  fund,  there  is  no  especial 
advantage  to  the  stockholders  except  that  which  may  accrue  in 
the  general  advantage  to  the  corporation.  A  frequent  practice 
is  to  place  a  certain  amount  of  the  surplus  in  gilt  edge  securi- 
ties of  other  corporations,  a  practice  which  insures  liquid  assets 
for  the  company  in  case  of  a  crisis  and  provides  collateral  in  a 
temporary  emergency.  These  securities,  like  all  others,  can 
only  be  considered  with  all  assets.  This  policy  again  indicates 
conservatism  and  the  greater  security  of  the  company. 

The  unconditional  acceptance  of  a  surplus  account,  as  indi- 
cative of  good  management  and  a  strong  company,  so  frequent 
with  investors,  has  no  warrant,  as  shown  from  the  above  condi- 
tions. The  origin,  character,  and  relation  of  the  surplus 
account  to  all  other  accounts,  must  be  known  before  any  con- 
clusion as  to  its  value  can  be  drawn.  Its  complete  analysis  is 
as  essential  as  that  of  any  other  account. 


CHAPTER  V 
ANALYSIS  OF  THE  CORPORATION  REPORT  (Continued] 

An  income  statement1  is  a  historical  summary  of  the  busi- 
ness over  a  period  of  time,  which  is  commonly  published  once  a 
year,  on  the  date  corresponding  to  the  issuance  of  the  balance 
sheet.  The  manager  of  a  company,  however,  must  have  these 
reports  at  more  frequent  intervals,  in  order  to  detect  any 
change  in  the  trend,  and  provide  an  immediate  check,  if  pos- 
sible. To  him  earnings  are  the  final  test  of  his  success.  To  the 
speculator  in  securities  frequent  reports  are  equally  important, 
as  his  profits  must  be  made  upon  the  knowledge  of  these  fluctua- 
tions. To  the  investor,  as  frequent  reports  are  not  so  essential. 
The  investor  selects  securities  of  sound  value,  and  as  he  is  inter- 
ested only  in  permanent  trends  and  not  in  temporary  fluctua- 
tions, less  frequent  reports  are  needed.  It  is,  however,  neces- 
sary for  the  investor  to  know  of  any  permanent  tendency  that 
portends  of  evil  consequence  to  the  corporation.  In  most  cor- 
porations the  careful  analysis  of  annual  reports  will  give  the 
danger  signal. 

The  first  caution  to  be  exercised  in  the  analysis  of  a  published 
income  report  is  to  make  certain  as  to  the  meaning  implied  in 
the  items  used.  The  different  interpretations  given  to  the  items 
in  the  income  statement  is  far  greater  than  in  the  balance  sheet 
items.  Even  the  best  accountants  vary  widely  in  the  use  of 
their  terminology.  It  is  to  be  hoped  that  the  same  standardiza- 
tion of  accounts  soon  may  be  secured  for  all  other  industries  as 
has  been  obtained  for  railroads.  It  is  unfortunate  that  this 
situation  prevails,  but  knowing  it,  the  examiner  can  be  on  his 
guard  in  making  his  interpretations,, 


*For  the  details  applicable  to  the  income  statement  of  a  particular 
type  of  company,  the  reader  is  -Deferred  to  the  particular  chapter  deal- 
ing with  the  security  under  consideration.  Only  an  outline  treatment 
of  the  income  statement  is  attempted  in  this  chapter. 

77 


78  INVESTMENT  ANALYSIS 

Not  infrequently  the  inexperienced  will  give  a  general  inter- 
pretation of  his  own  in  determining  how  exclusive  or  inclusive 
a  particular  item  may  be,  and  nothing  is  more  dangerous  than 
to  draw  deductions  under  these  conditions.  When  reports  are 
complete,  the  danger  from  this  error  is  very  much  minimized,  as 
a  comparison  of  items  quickly  reveals  their  main  content.  The 
expert  accountant  whose  familiarity  with  all  forms  of  corporate 
reports  enables  him  to  detect  the  difference  of  terms  and  imme- 
diately to  interpret  them,  often  does  not  appreciate  the  lay- 
man's handicap.  As  also  pointed  out  in  the  discussion  of  the 
balance  sheet  where  subsidiary  companies  exist,  both  a  consoli- 
dated income  statement,  and  a  separate  statement  of  the  indi- 
vidual properties  should  be  required. 

Income  accounts  of  the  average  published  corporation  report 
are  usually  quite  incomplete.  A  General  Income  Statement  of 
a  holding  company  shows  only  the  earnings  to  which  it  is 
entitled  from  the  subsidiary  properties;  these  earnings  include 
the  returns  from  both  stocks  and  bonds.  This  does  not  give 
any  clue  to  the  operating  conditions  of  the  subsidiary  proper- 
ties. If  the  earnings  of  the  company  have  also  come  from 
investment  securities — a  practice  which  enables  the  company 
to  maintain  itself — no  difference  may  be  shown  in  its  profits; 
yet  the  subsidiary  properties  may  be  on  the  verge  of  bankruptcy. 
Dividends  of  a  subsidiary  might  also  be  deferred  by  the  sub- 
sidiary through  an  agreement  of  the  majority  control  of  the 
holding  company,  though  the  General  Income  Statement  of  the 
holding  company  would  not  show  it.  Dividends  might  also  be 
continued  on  the  capital  stock  of  the  holding  company,  while  in 
order  to  maintain  these  dividends,  depreciation  charges  are 
partially  or  entirely  eliminated,  and  maintenance  cut  to  the 
danger  point. 

Gross  Sales,  Gross  Revenue,  Gross  Earnings. — In  any 
instance,  whatever  form  of  statement  is  used,  the  gross  revenue 
account  used  should  indicate  the  total  receipts  from  the  cor- 
poration's operations,  before  any  form  of  deductions  have  been 
made.  It  will  be  found  that  these  terms  are  used  differently, 
even  in  the  same  type  of  companies.  What  the  interpretation 
of  the  accounts  of  the  company's  own  auditor  is,  of  course, 


T9 

must  as  previously  stated,  be  ascertained.  In  particular  types 
of  business,  it  is  quite  clear  as  to  which  one  of  these  headings 
representing  gross  returns  should  be  used:  for  example,  in 
department  stores  gross  sales;  in  street  railways,  (preferably) 
gross  revenue  and  in  a  business  leasing  or  licensing  machinery, 
gross  earnings.  For  analysis  purposes  the  important  thing  to 
know,  regardless  of  these  technical  distinctions,  is,  what  is 
implied  in  the  particular  report. 

For  particular  purposes  or  for  the  concealment  of  the  actual 
earnings  and  to  make  a  showing  of  growth,  gross  returns  can 
often  be  easily  juggled.  This  again  is  proof  of  the  necessity  of 
a  reputable  certified  public  audit  of  the  accounts.  For  example : 
in  a  holding  company,  the  inter-company  accounts  may  also  be 
used  to  hide  vicious  practices  between  subsidiaries  in  order  to 
make  a  creditable  showing  for  the  company.  The  practice,  for 
illustration,  of  juggling  inter-company  sales  might  make  a 
favorable  showing  of  sales  when  the  contrary  is  true.  If  the 
company  had  a  severe  slump  in  its  business  in  any  one  year,  or 
.for  a  few  successive  years,  it  could  easily  use  this  method  in 
maintaining  the  appearance  of  a  continued  volume  of  business. 
A  few  years  ago  a  certain  Chicago  company,  which  had  approxi- 
mately a  20  per  cent  decrease  in  its  total  volume  of  sales, 
showed  an  actual  increase  in  this  year  of  5  per  cent  over  the 
previous  year.  The  same  over-statement  of  affairs  has  been 
made  by  the  use  of  the  construction  company,  of  which  we  have 
had  some  interesting  examples  in  the  last  twenty-five  years. 
This  is  accomplished  by  carrying  forward  inter-company 
profits.  While  these  are  practices  of  companies  which  would 
come  outside  the  pale  of  investments,  it  is  essential  to  know  the 
pitfalls  in  order  to  guard  against  them. 

Again  when  the  physical  valuation  has  been  used  as  a  basis 
for  rate-making,  there  is  an  advantage  in  having  the  increased 
re-valuation.  Also,  when  the  stockholders  desire  to  sell  the 
property,  it  is  desirable  to  re- value  assets  which  can  be  sold  for 
more  than  the  existing  book  value.  To  re-value  for  the  pur- 
pose of  showing  a  large  increase  in  earnings,  or  to  maintain 
previous  earnings,  which  may  be  decreased  because  of  rising 
price  of  products,  etc.,  is  quite  another  story.  This  is  not  a 


80  INVESTMENT  ANALYSIS 

defensible  practice,  and  is  more  frequently  used  to  hide  some 
shortcomings  of  the  corporation,  though  this  latter  must  not  be 
confused  with  the  adding  of  capital  surplus  which  is  justified. 
The  following  will  illustrate  the  former:  a  small  corporation 
having  a  bond  issue  outstanding,  and  desiring  to  make  a  stock 
issue  in  1916,  had  shown  an  increase  for  three  years  of  20  per 
cent  each  year  over  the  previous  year.  In  the  fourth  year,  this 
fell  to  a  2  per  cent  increase.  To  overcome  this,  the  equipment, 
etc.,  was  re-valued,  and  a  showing  of  a  25  per  cent  increase  was 
made.  Mr.  Eobert  H.  Montgomery  says  of  this  practice: 
" .  .  .on  the  basis  of  a  replaceable  valuation  less  depreciation 
worth  more  than  they  cost  originally  (business  men)  wish  to 
set  up  on  their  books  and  statements  this  diagnosis,  and  do  not 
like  to  be  told  that  they  are  making  trouble  for  themselves. 
They  have  a  larger  valuation  to  wipe  out  by  depreciation 
reserves,  and  thus  in  a  sense  they  are  increasing  their  cost  of 
production.  After  a  credit  to  surplus  account  is  once  made, 
it  is  most  unlikely  that  any  part  thereof  will  be  used  except  for 
dividends."1  Whenever  re-valuation  is  made,  it  should  be  car- 
ried as  a  distinct  item  and  be  properly  "earmarked."  Other 
illustrations  might  be  offered  but  this  will  suffice  to  show  what 
should  be  guarded  against.  Of  course,  no  company  following 
such  practices  could  be  classified  in  the  investment  group. 

The  gross  returns  from  credit  and  cash  sales  in  all  mercan- 
tile and  manufacturing  companies  should  be  given  separately, 
in  order  to  observe  both  the  working  capital  needs  and  the 
trend  of  the  business.  Credit  account  problems  of  the  kind 
referred  to  here  do  not  arise  in  public  utility  reports.  In  this 
connection  the  terms  and  duration  of  credit  extended  by  com- 
mercial corporations  and  manufacturing  plants  must  be  ana- 
lyzed in  the  relation  to  the  safety  of  the  company's  policy  and 
its  capital  requirements.  Again  in  commercial  and  manufac- 
turing corporations,  the  net  sales  item — that  is,  the  amount  left 
after  the  deduction  of  return  goods,  discounts,  etc.,  is  of  the  most 
importance,  in  some  cases  even  more  important  than  gross  sales. 
The  difference  between  gross  and  net  sales  in  these  corporations 


'Robert   H.    Montgomery,    Auditing    Theory    and    Practice    (1912),, 
p.  194. 


ANALYSIS  OF  REPORT  81 

is  relatively  larger  and  will  be  more  or  less  flexible,  according 
to  the  practices  and  policies  of  the  individual  corporation.  If 
percentage  comparisons  are  made  between  gross  and  net  sales, 
especially  where  a  comparison  is  made  with  other  corporations, 
care  must  be  used  to  see  that  they  are  both  on  the  selling  price 
or  both  on  the  cost  basis.  The  question  of  the  advantage  or 
disadvantage  of  either  method  of  comparison  belongs  to  the 
technical  problems  of  accounting.  Either  method,  for  purposes 
of  investment  analysis,  is  sufficiently  accurate. 

Another  useful  check  of  sales  or  income  which  can  also  be 
used  in  checking  all  working  capital  requirements,  is  a  com- 
parison of  these  accounts  with  sales.  In  making  such  a  com- 
parison the  period  required  for  making  and  selling  of  the  prod- 
uct must  be  first  ascertained.  If  the  inventories  are  then  too 
large  for  the  volume  of  the  sales,  a  needless  investment  is  being 
carried  which  may  be  indicative  of  a  lax  management.  It  may 
also  indicate  a  considerable  quantity  of  dead  inventory.  Where, 
however,  the  purchase  of  raw  material  can  be  made  at  certain 
periods  at  lower  cost,  a  large  inventory  may  indicate  a  decided 
advantage.  Also,  if  the  gross  profits  from  operations  compare 
favorably  with  the  earnings  of  the  former  periods,  there  is  little 
likelihood  of  inflations. 

Operating  Net  Income. — In  the  items  to  be  considered  and 
deducted  from  gross  returns  in  the  income  statement  to  secure 
the  net  profits,  some  distinction  must  be  made  between  the  state- 
ments of  Trading  Concerns  and  Manufacturing  Concerns,  and 
Public  Utilities  and  Railroads. 

In  the  first  two  forms  of  organizations  as  already  suggested, 
net  sales  is  the  next  thing  to  be  found  after  knowing  the  gross 
sales.  This  is  the  amount  available  after  the  deduction  of 
returned  goods,  allowances,  freight  charges,  etc.  Then  in  mer- 
chandise concerns  the  cost  of  sales  is  ascertained  by  taking  the 
amount  of  inventory  at  the  beginning  of  the  year,  plus  the  pur- 
chases, less  the  inventory  at  the  close  of  the  year.  The  net  sales 
less  the  cost  of  sales  then  gives  the  gross  profits.  By  deducting 
from  gross  profits  the  expense  of  doing  business  which  includes 
such  items  as  expenses  for  selling,  advertising,  building  expense, 
administration,  etc.,  net  profit  from  trading  is  secured.  In 


82  INVESTMENT  ANALYSIS 

manufacturing  concerns  instead  of  cost  of  sales,  manufacturing 
costs  which  include  such  items  as  labor  costs,  material  costs  and 
factory  expenses  are  used.  Distributing  costs  for  manufactures, 
on  the  other  hand,  are  much  the  same  as  those  for  trading 
organizations  if  performed  by  the  corporation  itself.  In  rail- 
roads and  public  utilities  these  items  are  generally  all  included 
under  operating  expense/ 

In  all  of  these  items  the  comparative  analysis  for  several 
years  is  of  value,  as  likewise  a  comparison  with  other  companies 
in  a  similar  field.  Here  again  difficulties  arise  in  comparing 
one  company  with  another.  Where  one  company  turns  back  a 
larger  proportion  in  maintenance,  depreciation,  etc.,  than  an- 
other company,  a  decrease  in  the  ratio  of  gross  profits  to  net 
sales  or  gross  revenue  would  not  necessarily  mean  that  the 
latter  company  is  in  a  stronger  financial  position.  The  former 
is  operating  on  a  more  conservative  basis.  Again,  the  emphasis 
which  must  be  placed  upon  any  one  of  these  groups  of  items 
depends  upon  the  conditions  under  which  the  corporation  is 
operating.  This  is  one  of  the  most  difficult  of  the  problems 
which  confront  us  in  the  analysis  of  corporations,  and  consid- 
erable practice  is  necessary  to  attain  skill  in  this  matter.  The 
particular  fundamental  details  essential  to  this  analysis  of  the 
different  types  of  securities  are  treated  under  the  respective 
headings  of  subsequent  chapters  of  corporate  securities. 

A  very  common  practice  and  a  good  one,  where  correctly 
used  in  testing  efficiency,  is  a  comparison  of  the  total  operat- 
ing expenses  to  gross  income.  To  make  this  comparison  more 
comprehensive,  it  is  made  on  a  ratio  or  percentage  basis,  and  is 
called  the  operating  ratio,  which  is  discussed  under  a  subse- 
quent topic. 

Practically  all  classes  of  corporations  will  show  a  relatively 
greater  increase  in  the  percentage  of  the  operating  ratio  to 
gross  earnings  as  gross  earnings  fall  in  a  business  depression. 
A  railroad,  for  illustration,  has  certain  fixed  operating  expenses 
which  must  continue  regardless  of  how  large  a  decline  exists  in 
traffic,  and  a  manufacturing  plant  with  a  certain  capacity,  out- 

^ee  chapter  xv  on  Railroad  Revenues. 


ANALYSIS  OF  REPORT  83 

put  has  developed  an  organization  which  in  part  at  least  must 
be  continued.  Neither  does  the  cost  of  materials,  labor,  etc., 
usually  decline  to  the  same  degree  as  gross  income.  In  com- 
parative analyses,  all  items  affected  by  these  two  conditions 
should  be  included,  in  order  to  give  a  correct  interpretation  to 
these  differences  in  declines  and  rises;  otherwise  the  value  of 
the  comparison  is  destroyed. 

Where  the  corporation  attempts  to  increase  its  net  income 
from  operating  by  reducing  its  operating  expense  through  a 
curtailment  of  repairs,  renewals,  and  maintenance,  the  earnings 
for  the  period  will  be  overstated.  The  charge  will  ultimately 
have  to  be  made  and  depreciation  will  be  hastened.  A  prop- 
erty must  be  kept  as  near  as  possible  to  its  original  efficiency. 
The  constant  temptation  under  periods  of  stress  is  to  curtail 
depreciation  charges,  especially  when  properties  are  new.  To 
keep  a  railroad  bed  or  a  machine  in  efficient  running  order  is 
as  essential  to  production  results  as  the  purchase  of  good  mate- 
rials and  the  use  of  efficient  labor  in  production.  If  actual 
additions  are  made,  such  as  new  buildings,  which  did  not  exist 
before,  they  should  be  charged  to  the  capital  account,  that  is,  as 
new  property. 

Sound  financing,  as  previously  suggested,  no  longer  ques- 
tions the  necessity  of  annually  setting  aside  an  allowance  suffi- 
cient to  cover  the  entire  replacement.  It  must  not  be  misun- 
derstood, as  so  commonly  believed  by  the  beginner,  that  these 
funds  are  reserved  in  the  form  of  cash.  These  funds  may 
actually  be  reserved  and  the  company  not  have  the  funds  to 
cover  the  entire  replacement  when  needed.  The  essential  thing, 
as  related  to  income,  is  its  allowance  in  the  deduction  from  cur- 
rent earnings.1 

Other  Income. — When  net  income  from  operation  has  been 
obtained,  net  income  from  other  sources  is  added  to  secure  total 
or  gross  income.  Other  income  which  includes  income  from 
all  other  sources  outside  of  operating  income  such  as  rent,  leases, 
interest,  etc.,  occasionally  amounts  to  a  considerable  propor- 

irThose  desiring:  to  obtain  a  more  complete  knowledge  of  deprecia- 
tion and  the  methods  of  depreciation  are  referred  to  the  general  texts 
in  accounting  and  corporation  finance. 


84  INVESTMENT  ANALYSIS 

tion  of  a  corporation's  revenue.  Where  other  expenses  exist  and 
must  be  met  before  the  net  amount  due  the  company  is  realized, 
the  deduction  must  first  be  met.  The  total  income  can  also  be 
viewed  from  the  standpoint  of  the  amount  available  for  fixed 
charges.  These  charges  include  sinking  fund  charges,  Federal 
taxes,  interest  charges,  etc.,  i.  e.,  they  are  considered  a  direct 
expense  of  capital  used  in  the  organization,  at  least  from  the 
standpoint  of  the  financial  analysis  of  the  property. 

The  major  portion  of  outside  returns  is  usually  from  invest- 
ments, and  consequently,  the  non-operating  income  gives  no 
clue  to  the  operating  efficiency  of  the  corporation.  Where  this 
income  is  very  large,  it  is  apt  to  hide  any  weakness  existing  in 
operating  returns,  which  is  the  very  thing  any  analysis  should 
disclose.  Investments  placed  in  corporation  securities  of  a  dif- 
ferent character  are  an  advantage,  especially  in  industrials,  in 
offsetting  reactions  in  the  operating  revenue.  Beyond  the 
amount  necessary  to  insure  this  risk,  it  is  questionable  whether 
this  surplus  should  not  be  placed  into  financing  property  expan- 
sions. Separations  should  also  be  made  between  operating  and 
non-operating  costs  for  the  same  reason. 

Fixed  Charges. — In  fixed  charges  are  included  such  items  as 
sinking  funds,  rentals,  taxes,1  lease  charges,  interest,  etc.  When 
these  charges  have  been  assumed  (except  taxes  which  are  levied 
by  the  State),  there  is  no  alternative  for  the  board  of  directors; 
they  must  be  paid,  when  due,  or  the  company  ceases  to  be 
solvent.  The  more  important  of  these  individual  items,  as 
related  to  investments,  are  the  interest  charges.  These  charges 
should  always  be  studied,  primarily  in  relation  to  net  operating 
income.  As  the  fixed  charges  are  assumed  for  the  purposes  of 
operation,  the  provision  for  these  charges  should  be  met  by  this 
fund  and  its  safety  determined  by  the  margin  of  the  operating 
net  income  over  the  fixed  charges.  Although  the  total  net  income 
is  available  for  interest,  the  real  test  is  the  margin  of  net  oper- 
ating income  over  the  fixed  charges  as  the  actual  success  of  the 
corporation's  earning  power  as  a  going  concern  is  measured  by 
the  income  derived  from  its  operations. 

'Many  accountants  would  not  term  taxes  technically  a  fixed  charge. 
For  the  purpose  of  obtaining  the  margin  over  all  permanent  charges,  it 
is  a  fixed  charge  in  investment  analysis. 


ANALYSIS  OF  REPORT  85 

Fluctuations  in  operating  expenses  will  not  rise  or  fall  to 
an  equal  degree  with  the  gross  returns.  Operating  expense, 
for  example,  will  always  increase  at  a  more  rapid  rate  than  the 
actual  rate  of  decline  of  gross.  For  illustration,  if  the  maxi- 
mum gross  returns  for  a  particular  period  were  made  equiva- 
lent to  100  per  cent  and  the  operating  ratio  to  75  per  cent  of 
gross,  and  gross  returns  should  decline  25  per  cent  and  operat- 
ing expense  at  the  same  time  should  go  to  90  per  cent,  a  smaller 
amount  would  be  left  for  net  income. 

Actual  Rate  Actual  Am't  After 
of  Decline.  Deducting  Am't  of 
Decline. 

Gross  Returns $1,000,000=  (100% )         25%         (75% )     $750.000 

Operating  Expense  ...      750,000=  (  75%)         15%         (90%)       675,000 
Balance  left  for   fixed 
charges 25%=$250,000 $  75,000 

The  reduction  of  this  latter  amount  correspondingly 
decreases  the  margin  of  safety  for  the  interest  charges.  This 
would  apply  as  well  to  any  comparative  analysis  with  other 
companies  and  to  all  of  the  other  constant  fixed  charges.  The 
maximum  amount  of  fixed  charges  which  a  corporation  should 
carry  with  safety  can  be  easily  determined  by  this  test.  The 
test  of  the  "times  interest  is  earned,"  which  is  so  often  used, 
is  also  dependent  on  the  same  set  of  facts.  A  common  mistake 
is  to  take  an  arbitrary  amount,  say  "interest  earned  twice 
over,"  and  to  use  this  as  a  standard  for  all  corporations,  making 
no  allowance  for  varying  conditions  affecting  security  of  earn- 
ings in  different  types  of  businesses.  ' '  Times  interest  is  earned ' ' 
must  always  be  taken  in  relation  to  the  character  of  the  busi- 
ness. Normally  with  the  decreasing  fluctuation  in  earnings, 
the  "times  interest  is  earned,"  other  things  being  equal,  should 
be  earned  to  give  ample  protection.  "With  increasing  fluctua- 
tion in  earnings,  the  "times  interest  is  earned"  should  be 
increased  at  more  than  a  proportionate  rate. 

Dividend  and  Surplus  Policies. — With  the  deduction  of  all 
the  items  which  are  included  in  fixed  charges,  net  profits  or  the 
balance  available  for  dividends  is  left.  Mr.  Robert  Montgom- 
ery defines  net  profit:  "The'net  profits  of  a  business  is  the  sur- 
plus remaining  from  the  earnings  after  providing  for  all  costs, 


86  INVESTMENT  ANALYSIS 

expenses,  and  reserves  for  accrued  or  possible  losses."  The 
importance  of  the  exact  significance  of  net  profits  is  misunder- 
stood by  many  investors.  This  is  not  surprising,  when  dealers 
in  securities,  especially  stocks,  are  quoting  net  income,  net  earn- 
ings, net  profits,  as  one  and  the  same,  as  available  for  dividends. 
Lack  of  rigid  standardization  in  accounting  terminology  has 
led  to  considerable  confusion,  and  investment  bankers  who  have 
accepted  certain  terminologies  use  these  terms  with  no  thought 
of  deception. 

A  banking  house  in  a  recent  circular  announcing  a  new  issue 
of  stock  for  sale  used  the  terms  net  earnings,  net  income,  and 
net  profits,  interchangeably,  all  referring  to  the  same  thing. 
The  interchange  of  net  income  and  net  profits  in  the  same  cir- 
cular has  not  been  infrequent.  If  terms  are  given  different 
meanings,  they  should  be  consistently  followed  and  again  let  it 
be  emphasized  to  the  beginner  to  make  sure  that  the  terminology 
of  a  statement  is  correctly  interpreted  before  he  begins  his 
analysis. 

Permanency  and  regularity  in  the  payment  of  dividends, 
rather  than  irregular  payment  of  large  or  small  dividends,  as 
earned,  are  always  indicative  of  a  sounder  financial  policy. 
Fluctuations  in  earnings  cannot  be  prevented  and  to  exhaust 
all  margins  undermines  both  the  credit  and  the  margin  of  safety, 
which  is  insured  to  the  creditors  by  the  policy  of  paying  a  mod- 
erate conservative  dividend  and  conserving  the  large  surplus  of 
"fat  years."  The  closed  corporation,  too,  controlled  by  a  very 
few  shareholders,  which  might  safely  follow  a  different  dividend 
policy  where  no  funded  debt  exists,  does  not  concern  the  invest- 
ment security  holder  and  need  not  be  discussed  here.  Even 
in  corporations  with  wasting  assets,  as  lumber  companies,  min- 
ing companies,  etc.,  this  rule  cannot  be  disregarded.  While  the 
final  exhaustion  of  resources  makes  necessary  a  provision  for  the 
return  of  all  capital  invested,  the  portion  returned  as  capital 
must  not  be  considered  as  a  part  of  dividends.  If  no  sinking 
fund  is  being  accumulated  for  the  final  retirement  of  capital, 
this  deduction  should  be  made  from  the  dividend  and  should  be 


'Robert  H.  Montgomery,  Auditing,  Theory  and  Practice  (1912),  p. 
184. 


ANALYSIS  OF  REPORT  87 

correspondingly  large.  The  practice  of  departing  from  this 
rule  by  the  payment  of  dividends  in  order  to  secure  apprecia- 
tion in  stock  prices  for  speculative  purposes  will,  of  course, 
immediately  rule  any  security  out  of  the  investment  class  if  it 
ever  belonged  to  this  class. 

Dividends  may  also  be  paid  out  of  accumulated  surplus  or 
from  the  sale  of  assets  at  more  than  their  par  value  or  book 
value.  As  this  latter  is  a  sale  of  capital  assets,  and  also  not 
derived  from  earnings,  it  should  be  made  distinct,  as  already 
indicated,  from  income  derived  from  earnings.  It  is  question- 
able, however,  whether  dividends  should  be  paid  out  of  surplus, 
except  at  rare  intervals.  Frequent  recourse  to  this  procedure 
would  at  once  make  the  credit  obligations  of  such  a  corporation 
a  speculative  issue. 

Surplus  is  placed  in  the  property  and  is  for  all  practical 
purposes  the  same  thing  as  a  direct  capital  investment.  With- 
drawal means  a  weakening  of  the  corporation  and  is  a  poor 
practice,  except  where  savings  bank  requirements,  etc.,  must 
be  maintained  because  of  the  company's  credit.  This  is, 
however,  justified  only  where  it  will  not  be  repeated.  The  pay- 
ment of  stock  dividends  out  of  surplus  is  of  no  material  differ- 
ence to  the  investor,  for  the  payment  of  a  lower  dividend  upon 
a  large  amount  of  capital  does  not  disturb  his  equity.  Capital 
stock  and  surplus  representing  capital  assets  have  only  been 
consolidated  into  the  one  account  of  capital  stock  a  procedure 
which  does  not  change  the  amount  or  character  of  the  capital 
assets.  Many  creditors  always  look  with  suspicion  upon  the 
safety  of  their  holdings  whenever  a  capital  stock  dividend  is 
paid.  This  attitude  is  without  foundation. 

Surplus,  it  has  been  emphasized,  does  not  necessarily  mean 
cash,  even  where  a  surplus  balance  is  carried  forward  to  the  end 
of  the  year.  Corporations  have  not  infrequently  borrowed 
under  these  conditions  when  a  large  investment  was  tied  up  in 
inventories,  receivables,  etc.,  in  order  to  pay  their  dividends. 
When  future  cash  earnings  are  soon  available,  as  in  the  monthly 
receipts  of  telephone  companies,  there  may  be  justification  in 
doing  this;  as  a  rule,  corporations  following  this  policy  have 
sooner  or  later  suffered  from  the  result.  Especially  is  this  true 


88  INVESTMENT  ANALYSIS 

where  net  current  assets  form  a  large  ratio  to  the  total  capitali- 
zation. To  still  further  weaken  an  already  strained  position, 
is  to  expose  this  corporation  at  its  most  vulnerable  point. 

In  studying  the  cash  and  dividend  position  of  the  company, 
a  check  should  be  made  with  current  assets  and  liabilities  and 
the  future  cash  demands  for  the  year.  These  needs  may  be 
imperative;  for  example,  a  corporation  may  have  had  large 
earnings,  but  a  sudden  slowing  up,  at  the  end  of  the  year  and 
continuing  through  the  next  year,  would  call  for  a  considerable 
drawing  upon  resources,  especially  if  the  ratio  of  current 
liabilities  is  large.  Even  normally  the  future  current  liabilities 
should  be  closely  studied  before  finally  passing  upon  the  divi- 
dend policy.  A  corporation  may  also  be  prevented  from  tak- 
ing advantage  of  the  purchase  of  materials,  if  its  cash  is 
depleted.  When  betterments  and  extensions  are  being  made, 
an  added  burden  is  placed  upon  cash  requirements  which  must 
be  checked  with  even  greater  care. 

One  of  the  surest  tests  of  the  character  of  a  corporation's 
financial  policy  is  its  distribution  and  application  of  funds 
applied  out  of  surplus  earnings  to  expansion.  "While  it  is 
assumed  that  the  equity  back  of  an  investment  security  is  suffi- 
cient at  the  start,  the  enhancement  of  the  holders'  securities 
and  the  danger  against  lapses  is  insured  when  liberal  allowance 
is  made  from  earnings  to  finance  new  projects.  Sound  financ- 
ing requires  carrying  loans  to  a  maximum  point  of  safety,  but 
corporations  which  have  financed  all  expansions  through  loans 
have  never  enjoyed  the  financial  strength  of  those  corpora- 
tions which  have  diverted  a  portion  of  their  earnings  to  new 
expansion.  Distinction  must  be  made  between  the  betterments 
which  will  bring  immediate  returns  and  those  from  which  the 
return  will  be  spread  over  a  long  series  of  years.  As  a  rule, 
the  former  should  be  largely  financed  out  of  current  earnings, 
and  the  major  portion  of  the  latter  from  the  bond  issues.  For  a 
further  consideration  of  surplus  the  reader  is  referred  to  the 
discussion  of  surplus  in  the  previous  chapter. 

Statistical  Units  of  Measurements  Used  in  Analysis. — The 
use  of  statistical  units  of  measurement  is  coming  into  such  gen- 
eral practice,  especially  in  relation  to  income  that  a  word  of 


ANALYSIS  OF  REPORT  89 

comment  concerning  their  possibilities  and  limitations  seems 
necessary.  The  large  amount  of  data  needed  to  establish  and  to 
prove  statistically  a  certain  standard  correct,  places  a  decided 
limit  upon  the  number  of  standards  which  have  been  adequately 
tested.  Large  organizations  and  associations  to  whom  sufficient 
original  data  are  available  must  do  this  for  future  scientific  pur- 
poses. Despite  rigid  requirements,  there  are  a  few  very  useful 
standards  which  will  be  found  in  subsequent  chapters.  As  is 
often  implied  in  these  pages,  in  no  single  instance,  however, 
should  a  single  one  of  these  units  of  measurement  be  used  as 
giving  final  evidence. 

It  would  be  impossible  to  detect  with  one  or  two  units  either 
the  possible  variations  or  the  existence  of  other  influences  that 
might  wholly  destroy  the  value  of  any  conclusions  that  might 
be  drawn.  This  is  a  common  error,  emphasized,  for  example, 
in  the  use  of  public  utility  statistical  data,  where  units  of 
measurements  that  are  meaningless  can  so  easily  be  devised. 
Even  where  a  single  standard  unit  has  long  been  accepted  as 
the  basis  of  accurate  measurement,  conclusions  from  it  may  be 
entirely  misleading  unless  qualified.  Though  a  complete  survey 
or  list  of  the  standards  that  have  been  used  cannot  be  given  in 
these  pages,  three  or  four  are  sufficient  to  indicate  their  possi- 
bilities and  limitations.  Others  will  be  given  in  subsequent 
chapters. 

Innumerable  uses  have  been  made  of  illegitimate  standards, 
and  especially  of  a  number  of  perfectly  absurd  standards  that 
have  been  created  by  the  individual  with  the  one  idea  of  meas- 
uring all  things  by  this  one  rule.  Apparent  though  it  may  seem, 
the  character  of  the  standard  used  needs  greatest  emphasis. 
Certainty  of  its  accuracy  must  be  assured,  and  its  test  must  be 
sufficiently  wide  to  make  certain  that  a  real  standard  is  being 
used.  A  unit  superficially  tested  has  often  proven  quite  accu- 
rate in  two  or  three  cases,  and  when  applied  to  a  wider  range  of 
tests  has  completely  broken  down.  Correctly  used,  nothing  can 
give  so  comprehensive  an  understanding  as  an  accurate  stand- 
ard unit  of  measurement. 

Such  frequent  mistakes^  are  made  in  comparative  analysis 
that  care  should  be  taken  that  similar  things  are  compared.  It 


90  INVESTMENT  ANALYSIS 

is  entirely  wrong,  for  example,  to  compare  the  earnings  per  mile 
of  a  coal-carrying  road  with  the  earnings  of  an  agricultural 
system.  A  packing  company  giving  short  term  credit  cannot  be 
compared  with  one  manufacturing  heavy  farm  machinery  and 
giving  long  time  credit.  The  capital  problem  of  a  mail  order 
house  cannot  be  compared  with  that  of  a  steel  company  or  the 
latter  with  the  problem  of  an  oil  producing  concern.  Com- 
parisons estimating  future  growth  on  the  basis  of  what  certain 
other  companies  in  similar  businesses  have  accomplished  are 
even  more  misleading.  Simple  and  obvious  as  this  is,  it  is  so 
suggestive  a  selling  point  and  so  readily  accepted,  that  it  is  at 
the  present  more  widely  used  than  ever.  Circulars,  especially 
those  offering  speculative  issues  for  sale,  make  this  unwarranted 
claim  of  guarantee. 

Opposed  to  these  general  contentions  for  accuracy  of  the  cri- 
terion used,  there  are  certain  criteria  which  are  known  to  be 
incorrect,  because  incomplete,  but  which  help  in  obtaining  the 
first  general  estimates.  If  the  ratio  or  result  obtained  for  the 
company  considered  is  somewhat  near  that  of  the  accepted 
standard,  it  at  least  warrants  a  further  examination  of  the  prop- 
erty. Or,  where  sufficient  other  evidences  of  the  company's 
condition  are  had,  it  may  be  accepted  as  an  additional,  though 
qualified  check  of  the  company's  status.  A  good  illustration  cf 
this  is  the  generally  accepted  percentage  of  costs  of  conducting 
business  to  gross  sales  in  certain  retail  businesses,  or  the  over- 
head costs  and  selling  costs  of  a  manufacturing  plant  to  the 
price  of  the  article. 

In  railroads  the  mile  unit  of  track  has  probably  been  the 
longest  established,  and  is  the  most  widely  accepted  of  the  stand- 
ards of  measurement.  The  magnitude  of  the  sums  involved  in 
railroad  finance,  the  great  difference  in  the  total  business  done, 
and  the  difference  and  changes  in  the  mileage  to  total  earnings, 
make  any  comparisons  of  a  railroad's  own  earnings  from  year 
to  year,  and  especially  comparisons  with  other  roads,  vague 
even  to  an  expert  unless  they  can  be  reduced  to  some  common 
unit.  When  tonnage,  earnings,  maintenance,  fixed  charges,  etc., 
are  reduced  to  the  basis  of  the  amount  per  mile,  financial  results 
are  put  in  such  a  form  that  a  comparison  can  be  made  with  any 


ANALYSIS  OF  REPORT  91 

system,  regardless  of  the  size  of  business  or  mileage.  It  is  in- 
deed doubtful  if  a  railroad  report  is  ever  fully  understood,  until 
it  has  been  reduced  to  this  common  basis  of  analysis. 

The  so-called  operating  ratio,  one  of  the  more  common  forms 
of  standards  of  measurement  used  in  the  analysis  of  public  utili- 
ties, has  been  subject  to  much  abuse.  The  operating  ratio  is 
obtained  as  follows:  the  gross  revenue  is  given  a  standard  of 
100  per  cent,  so  that  the  difference  between  this  percentage  and 
the  percentage  of  total  expense  gives  the  net  gross  returns. 
Any  type  of  business  which  has  a  high  operating  cost,  other 
things  being  equal,  has  a  small  margin  upon  which  to  insure 
itself  against  a  depression  of  business.  In  such  a  business,  cer- 
tain years  would  yield  very  large  profits  and  in  others  the  mar- 
gin of  gains  would  be  very  small,  a  condition  making  it  unsafe 
to  carry  a  very  large  fixed  charge.  With  a  low  operating  ratio 
the  reverse  would  be  true.  As  the  amount  in  the  fixed  prop- 
erty account  increases,  it  will  normally  be  found  that  the 
operating  ratio  decreases  in  the  corporation  which  can  be  classed 
in  the  investment  group  of  corporations. 

The  operating  ratio  is  of  the  utmost  significance  when  it  is 
considered  in  relation  to  the  other  accounts  of  the  company. 
Considered  unrelatedly,  it  is  meaningless.  Unfortunately,  it  is 
most  frequently  used  in  this  way.  For  example,  one  com- 
pany in  a  recent  annual  report  shows  an  operating  ratio  of  45 
per  cent  of  gross  returns  and  another  60  per  cent,  although  the 
net  return  per  mile  of  street  car  track  of  the  latter  is  larger 
than  that  of  the  former.  This  is  explained  by  the  fact  that 
the  total  capital  investment  per  total  gross  earnings  is  much 
lower  in  the  company  with  the  large  operating  ratio,  a  fact  which 
at  once  destroys  the  value  of  any  comparison  of  the  operating 
ratios  of  these  two  companies  not  taking  this  into  consideration. 

It  is  possible  for  a  company  to  increase  its  traffic  by  lower- 
ing its  rates,  thus  increasing  its  total  net  earnings,  though  the 
operating  expense  has  increased.  A  low  operating  expense  may 
mean  that  the  rates  are  higher,  or  service  is  unsatisfactory. 
Where  fares  are  low,  the  operating  ratio  may  be  high,  though 
the  cost  per  car  mile  be  very  low.1  Long  hill  climbs  and  more 

'The  cost  of  running  oue  car  one  mile. 


92  INVESTMENT  ANALYSIS 

widely  dispersed  population  may  again  so  increase  the  operat- 
ing ratio  that  a  well  managed  company  would  seem  badly  man- 
aged, though  its  net  profits  are  high  and  vice  versa.  Great 
density  of  traffic  and  low  fixed  charges  in  several  cases  permit 
high  operating  rates  and  yield  good  returns.  A  very  heavy 
fixed  investment  in  purchases  or  improvements  that  reduces  the 
cost  of  operation,  will  reduce  the  ratio  of  operation,  though  it 
is  possible  that  the  cost  of  the  fixed  investment,  as  found  in  a 
few  companies,  was  not  only  unwarranted,  but  has  placed  a 
heavier  burden  on  the  company  in  fixed  charges  than  the  larger 
operating  ratio  would  have  been.  A  lower  operating  ratio 
would  then  belie  itself. 

A  very  common  unit  of  measurement  used  is  the  number 
per  capita  to  consumer,  mile  of  track,  kilowatt  capacity,  etc. 
Correctly  used,  this  gives  one  of  the  most  accurate  means  of 
determining  efficiency,  earning  strength,  and  future  possibilities 
of  the  company.  But,  while  every  public  utility  analyst  recog- 
nizes the  importance  of  the  number  and  density  of  population 
upon  the  amount  of  income,  other  variables  may  largely  coun- 
teract this  advantage  which  a  company  may  possess.  There  is, 
for  example,  an  interurban  in  the  Middle  Western  states  which 
has  a  population  per  mile  of  track  equal  to  three  times  that  of 
an  interurban  railway  in  a  neighboring  state,  but  the  former 
has  lower  gross  earnings  than  the  latter.  Another  system  in 
the  same  territory  with  one-fifth  the  number  of  inhabitants  per 
mile  of  track,  earns  three  times  as  much.  The  population  ad- 
joining two  of  these  companies  evidently  takes  either  longer 
or  more  frequent  rides,  or  both.  Normally,  it  would  be  expected 
that  the  railway  with  the  greatest  population  adjoining  its 
right  of  way  would  show  the  largest  earnings.  But  an  exam- 
ination of  the  operating  revenue,  amount  of  funded  debt,  etc., 
shows  an  entirely  different  re]ationship  in  the  three  companies. 
The  number  per  capita  per  "other  unit"  may  be  large,  but  if 
the  population  is  closely  concentrated  or  a  limited  amount  of 
riding  is  necessary,  or  the  riding  habit  has  not  become  preva- 
lent among  a  large  part  of  the  inhabitants,  the  company  will 
not  show  large  earnings.  Mere  per  capita  numbers  will  not 
reveal  these  facts. 


ANALYSIS  OF  REPORT  93 

Again  a  certain  electric  light,  power  and  railway  company 
last  year  made  the  statement  in  its  annual  report  concerning  its 
electric  light  proceeds,  that  earnings  had  been  increasing  faster 
than  population.  This  does  show  an  increasing  strength 
on  the  part  of  the  company,  but  it  does  not  mean  all  that  a 
superficial  examination  would  purport  to  convey.  While  the 
total  amount  of  gross  earnings  is  growing  faster  than  the  total 
population,  the  ratio  of  increase  of  the  former  per  capita  is  less 
than  it  was  eight  years  ago.  In  this  instance  the  larger  con- 
sumers are  fewer  and  the  number  of  small  consumers  are  the 
chief  source  of  the  increase.  This  will  eventually  mean  a  de- 
crease in  the  ratio  of  net  earnings  unless  operating  expenses 
have  been  correspondingly  cut  down  without  sacrifice  to  the 
company.  A  number  of  companies  with  a  net  per  capita 
decrease  and  a  reduction  of  operating  expenses  through  per- 
manent economies,  have  succeeded  in  building  up  a  larger 
permanent  net  profit  which  offsets  the  objection  to  the  per 
capita  decrease  in  the  company. 

Another  illustration  of  a  statistical  unit  of  measurement  is 
the  so-called  "rate  of  turn-over  of  working  capital,"  i.e.,  the 
ratio  of  gross  sales  to  the  working  capital  carried  during  a 
given  period.  This  average  is  based  upon  the  average  amount 
of  working  capital  carried  during  the  year.  This  measurement 
is  sometimes  made  to  the  total  assets,  but  this  is  not  so  accurate. 
More  use  can  be  made  of  this  unit  in  commercial  establishments 
than  in  manufacturing  concerns.  Where  the  operating  ratio  has 
been  the  predominant  standard  measurement  used  in  public 
utilities,  "the  rate  of  turn-over"  has  been  used  in  commercial 
corporations.  And  in  proportion  to  the  amount  that  any  cor- 
poration has  its  funds  invested  in  working  capital,  it  is  inter- 
ested in  the  problem  of  turn-over.  If,  of  course,  long  time 
credit  can  be  procured  and  goods  sold  on  short  time  credit,  the 
necessity  of  working  capital  would  be  of  little  importance.  On 
the  other  hand,  the  more  rapid  that  the  turn-over  can  be  made, 
the  smaller  will  be  the  amount  that  the  company  will  have  to 
carry  in  this  form  of  capital.  In  the  case  of  the  manufacturer, 
the  rate  of  turn-over  is  largely  determined  by  the  period 
needed  for  production.  If  it  is  a  long  period,  the  increase  of  vol- 


94  INVESTMENT  ANALYSIS 

ume  will  not  increase  the  turn-over  beyond  a  certain  point.  If 
the  rate  of  turn-over  in  the  business  falls  short  of  the  normal 
rate,  it  will  reveal  one  of  two  things:  either  that  the  manage- 
ment has  failed  to  appreciate  the  necessity  of  taking  small 
profits  to  increase  the  volume  of  sales,  or  the  sales  department  is 
weak.  This  unit  offers  an  excellent  check  on  efficiency. 

A  form  of  measurement  that  is  employed  in  the  companies 
in  which  the  rate  of  turn-over  to  working  capital  is  used,  is 
the  ratio  of  working  capital  to  the  total  capital,  and  also  the 
ratio  of  the  items  constituting  working  capital  to  each  other.1 
In  industries  of  a  similar  type,  the  proportions  of  working  capi- 
tal to  the  total  capital  should  be  confined  to  proportions  of 
fairly  narrow  range.  When  comparisons  between  companies 
are  made,  a  strict  classification  of  similar  types  of  companies 
must  be  assured,  for  a  difference  in  even  a  considerable  pro- 
duction of  by-products  will  make  a  difference  in  these  ratios. 
Where  the  term  of  credit  is  short,  the  period  of  production  is 
short  and  turn-over  quick,  and  the  terms  of  purchase  short,  the 
corporation  is  not  seriously  set  back  by  seasonable  changes,  for  if 
financial  pressure  is  imminent,  its  stock  can  be  quickly  dis- 
posed of. 


'See  chapter  xxvi,  on  Industrial  Bonds  for  a  detailed  discussion  of 
the  relation  of  the  items  that  make  up  working  capital. 


CHAPTEE  VI 
NEGOTIATION  AND  ISSUANCE 

When  the  directors  of  a  corporation  or  the  officials  of  a 
civil  division  decide  that  it  is  desirable  to  secure  additional 
funds,  the  character  and  amount  of  the  funds  that  can  be 
obtained  to  the  best  advantage  are  dependent  upon  the  many 
conditions  discussed  throughout  this  volume.  Discussion  of  this 
whole  problem,  then,  is  eliminated  here  and  only  some  of  the 
typical  methods  by  which  these  funds  may  be  raised  and  the 
procedure  by  which  the  issue  is  created  are  considered.  The 
details  of  negotiation  and  issuance  vary  widely  in  practice, 
though  the  important  underlying  requirements  are  much  the 
same. 

The  borrower  who  seeks  to  obtain  funds  at  the  best  advan- 
tage realizes  that  certain  methods  and  types  of  securities  serve 
particular  purposes.  The  plans  generally  followed  are:  First, 
where  funds  are  wanted  only  for  a  few  weeks,  they  are  procured 
from  a  bank  either  on  personal  credit  or  through  a  loan  made 
on  the  security  of  current  receivables  (accounts  or  notes  receiv- 
able) of  the  company.  Second,  where  the  company  desires 
the  use  of  the  funds  for  a  few  months,  a  more  formal  issuance 
of  notes  is  made.  While  notes,  usually  constitute  a  general 
claim  against  assets  which  corresponds  to  the  lien  of  debenture 
bonds,  not  infrequently  specific  assets  are  placed  in  security. 
In  industrials,  current  receivables  are  most  frequently  used. 
Notes  are  often  employed  as  a  temporary  expedient  to  secure 
the  use  of  funds  needed  immediately,  until  a  more  favorable 
market  exists  to  float  a  long  time  loan.  In  civil  divisions,  the 
resort  to  temporary  loans  is  made  through  the  issuance  of 
warrants,  commonly  called  ''anticipation  warrants,"  which  are 
claims  against  the  future  funds  that  the  municipality  or  other 
civil  division  acquires  through  taxation.  Third,  the  long  time 

95 


96  INVESTMENT  ANALYSIS 

loan  is  issued  in  the  form  of  bonds,  the  security  for  which  is  a 
common  mortgage  against  specified  property  of  the  corpora- 
tion or  the  general  taxes  of  the  civil  division.  Legally,  there 
is  no  distinction  between  the  second  and  third  plans,  and  as  a 
matter  of  fact,  with  corporate  issues,  duration  is  the  only  claim 
to  real  distinction. 

Where  the  risks  are  greater,  or  the  possibility  of  risks  exists, 
or  the  management  wishes  to  continue  its  present  control,  stock 
issues  are  used  instead  of  loans.  This  gives  the  corporation  the 
advantage  of  never  being  in  danger  of  foreclosure.  If  the  risk 
is  great,  a  bond  issue  would  also  have  a  wide  range  in  price  and 
would  be  more  likely  to  prove  a  serious  hindrance  to  the  cor- 
poration's current  credit  needs.  This  does  not  argue,  however, 
that  a  great  many  of  the  outstanding  stock  issues,  especially 
preferred  stocks,  are  not  a  very  much  better  purchase  than 
many  bond  issues.  A  more  ready  market  due  to  higher  rates 
has  often  made  it  more  advantageous  for  small  corporations  to 
issue  stock. 

Authorization  of  the  Issue. — The  first  step  in  issuing  bonds, 
notes,  or  mortgages,  is  to  secure  the  legal  authority  to  make  the 
issue.1  The  law  very  definitely  stipulates  for  both  private  cor- 
porations and  governments  the  source  of  authority  and  the 
rights,  powers,  and  limitations  which  are  placed  upon  the  exer- 
cise of  this  privilege.  The  legal  counsel  of  the  banker  must 
consequently  use  the  greatest  care  in  ascertaining  wrhether  all 
legal  requirements  have  been  fully  met. 

In  the  issue  of  bonds  by  a  corporation  the  board  of  directors 
takes  the  initiative  in  proposing  an  issue.  After  the  board  of 
directors  decides  to  make  an  issue  of  bonds,  notes,  or  mortgages, 
and  officially  acts  upon  the  issue,  it  is  better  practice,  and  is 
required  by  the  statutes  of  some  states  that  the  stockholders 
approve  the  issue,  although  in  the  absence  of  statutes  the 
directors  have  the  power  to  issue  bonds  for  corporate  purposes. 
In  addition  to  this,  railroads,  as  well  as  other  public  utilities, 


'Thomas  Conyngton.  Revised  by  H.  Potter  (1919)  Corporation  Or- 
ganisation and  Management,  chapter  li,  particularly  sections  38'^-382. 
This  text  gives  a  good  summary  of  the  manner  of  authorization  and 
issue 


NEGOTIATION  AND  ISSUANCE  97 

practically  always  must  obtain  permission  for  any  issue  of  secu- 
rities from  a  public  utility  or  railroad  commission.  The  blue 
sky  laws  of  the  state  involved  should  be  consulted,  although 
owing  to  the  newness  of  the  blue  sky  enactments,  and  their 
probable  development  within  the  next  few  years,  no  definite 
statement  is  attempted  here.  The  completeness  and  accurateness 
of  information  demanded  by  the  respective  states  vary  widely 
and  still  lack  standardization.  A  recital  of  the  compliance  with 
all  these  requirements  should  be  included  in  the  mortgage.1 

A  corporation  has  the  right  to  issue  bonds  or  notes  for  any 
purpose  which  comes  within  its  right  of  contracting  a  debt. 
This  right  to  issue  securities  is  an  implied  power  of  the  cor- 
poration and  need  not  be  stated  in  its  charter,  but  restrictions 
upon  the  power,  if  any,  in  the  charter,  the  state  constitution,  the 
statutes,  or  the  judicial  decisions,  must  be  carefully  observed. 
If  any  securities  have  been  issued  in  violation  of  such  restric- 
tions, the  Courts  have  usually  decreed  them  void.  If  it  was 
an  intentionally  fraudulent  issue,  the  officials  or  stockholders 
are  held  personally  liable.  If  the  stockholders  are  required  to 
give  their  assent  and  have  not  done  so,  neither  the  corporation 
nor  the  bondholders  have  any  recourse  in  holding  the  stock- 
holders accountable  for  the  validity  of  the  issue. 

The  authorization  of  state  and  municipal  bonds  is  made  by 
the  legislative  body  of  the  state  or  other  civil  division,  subject 
to  the  regulation  and  limitations  of  the  state  constitution  and 
its  revenue  statutes.  When  the  proposed  issue  is  passed  by  this 
body,  it  then  must  usually  be  approved  by  a  certain  number  of 
the  voters  of  the  civil  division  making  the  issue,  the  details  of 
the  procedure  being  fully  covered  by  statute.  In  a  few  states 
the  legality  of  the  issue  must  also  be  approved  by  the  State.2  It 
is  now  rare_  that  a  minor  civil  division  must  secure  legislative 
action  for  a  particular  issue.3  The  authority  to  make  the  issue 


'See  chapter  vii.  Corporation  Mortgage. 

2See  chapter  viii.  Registration.  Transfer  and  Assignment  of  Secu- 
rities and  Their  Validity  and  Legality. 

3Such  requirements  as  advertising  prior  to  accepting  bids,  proper 
notification  of  voting,  provisions  for  interest  charges,  and  of  the  prin- 
cipal at  maturity,  etc.,  illustrate  the  character  of  the  legal  requirements 
made  by  statutes. 


98  INVESTMENT  ANALYSIS 

having  been  secured,  the  corporation  or  municipality  can  either 
proceed  to  dispose  of  its  own  securities  or  to  procure  the  serv- 
ices of  a  banker  to  undertake  the  marketing  of  the  securities. 

The  Investigation. — After  the  corporation  or  civil  division 
has  decided  to  issue  securities,  a  banker  must  be  found  to  handle 
the  financing,  unless  the  officials  of  the  respective  organizations 
decide  to  have  the  corporation  do  its  financing  direct.  After  a 
banker  has  been  found  who  will  listen  to  the  proposition  and  to 
whom  it  appeals  as  a  desirable  one,  a  preliminary  investigation 
is  made  to  ascertain  whether  the  proposition  shall  be  given  fur- 
ther consideration.  Where  the  original  evidence  furnished  is 
complete  enough  or  the  banker's  previous  intimacy  with  affairs 
justifies,  the  preliminary  investigation  is  passed  over  and  the 
more  complete  investigation  is  immediately  undertaken  with  the 
agreement  that  the  securities  will  be  underwritten  by  the  banker 
if  the  investigation  proves  the  original  facts  to  be  as  repre- 
sented. 

The  investigation  will  follow  four  main  lines:  (1)  of  the 
legality;  (2)  of  the  financial  status;  (3)  of  the  physical  prop- 
erties; (4)  of  the  management.  The  lawyer  must  make  a  com- 
plete examination  of  legal  points  involving  authorization  of  the 
issue,  the  rights,  forms,  etc.,  for,  regardless  of  how  strong  finan- 
cially the  corporation  may  be,  a  legal  error  might  nullify  the 
issue.  To  the  accountant  is  submitted  the  task  of  making  a 
complete  audit  of  the  company  over  a  period  of  years  to  obtain 
complete  information  concerning  its  financial  condition.  The 
engineer  makes  the  valuation  of  all  physical  properties,  patents, 
costs  of  construction,  etc.,  and  the  effect  of  the  present  manage- 
ment's policies  upon  the  plants.  The  personnel  of  the  manage- 
ment is  thoroughly  investigated,  and  where  it  is  a  corporation 
coming  under  regulatory  power,  as  a  public  utility,- the  policies 
and  rulings  are  examined,  particularly  in  relation  to  their  effect 
upon  the  earnings  of  the  company.  In  short,  this  investigation 
is  based  upon  the  underlying  principles  laid  down  in  this  text. 
When  these  reports  have  been  made  to  the  banker,  he  correlates 
the  facts  submitted  to  him  from  all  sources  and  analyzes  them 
and  checks  them  against  his  previous  experiences.  Where  the 
municipality  and  the  laws  of  the  state  are  well  known,  the 


NEGOTIATION  AND  ISSUANCE  99 

banker  only  examines  the  statement  submitted  by  the  auditor  of 
the  municipality  to  see  whether  the  municipality  has  conformed 
to  the  debt  limit,  tax  rate  requirements,  etc.  When  the  allot- 
ment has  been  made  to  the  investment  house,  its  counsel 
rechecks  the  legality  of  the  procedure.  The  right  to  pass  upon 
the  legality  of  the  issue  is  the  qualifying  condition  of  the  bid 
allowed  the  banker.  If  the  legality  of  the  issue  is  approved  by 
counsel,  the  issue  is  accepted  by  the  banker. 

A  banker,  even  though  he  finds  the  security  meets  all  the 
requirements  of  an  ideal  investment,  must  determine  the  answers 
to  two  other  questions.  The  first  is  purely  an  individual  and 
personal  one  with  his  institution;  the  other  is  of  general  im- 
portance. First,  is  this  the  type  of  security  which  he  can  sell 
to  his  clientele?  Second,  what  is  the  market  for  securities 
at  this  time ;  can  it  readily  absorb  the  issue  in  question  ?  Does 
the  market  favor  the  type  of  security  to  be  issued?  Corpora- 
tions and  bankers  consider  this  so  important  that  provisional 
means  are  used  in  securing  funds  where  their  need  is  impera- 
tive, in  order  to  await  a  more  favorable  market.  The  War 
experiences  have  given  innumerable  illustrations  of  corporations 
forced  to  make  temporary  loans. 

Before  the  banker  can  proceed  to  offer  his  securities  for  sale, 
two  other  important  steps  must  be  taken.  A  trustee  for  the 
mortgage  must  be  procured,  and  the  instrument  prepared  and 
printed.  The  mortgage  upon  which  the  bonds  are  issued  is 
deposited  with  a  trustee,  usually  a  trust  company.  This  trustee 
receives  all  interest  payments  every  six  months  from  the  cor- 
poration, and  repays  these  amounts  to  the  bondholders,  as  well 
as  the  principal  when  it  is  due.  The  trustee  also  certifies  that 
each  bond  issued  by  the  corporation  is  genuine  and  that  the 
amount  issued  is  authorized.  The  trustee  also  is  the  common 
representative  of  the  bondholders,  and  if  the  corporation  vio- 
lates any  part  of  its  contract  in  the  mortgage  against  the 
interests  of  the  bondholders,  the  trustee  takes  legal  action  as 
their  agent.  If  any  interest  payments  or  principal  are  not 
paid,  the  trustee  also  brings  foreclosure  proceedings  as  repre- 
sentative of  the  bondholders.1  This  procedure  of  trusteeship, 


'See  chapter  vii,  for  a  more  complete  discussion  of  this  topic. 


100  INVESTMENT  ANALYSIS 

of  course,  does  not  apply  to  civil  loans,  which  do  not  have  a 
mortgage  security. 

The  necessity  of  a  careful  preparation  of  the  instrument 
which  is  the  evidence  of  the  holders'  claims  is  important,  both 
to  insure  that  it  is  legally  correct,  and  to  prevent  counterfeiting. 
The  stock  exchanges  now,  without  exception,  require  that  all 
bonds  listed  and  passing  through  the  exchange  shall  be  certified 
as  to  genuineness  by  a  trustee.  When  the  instruments  have 
been  properly  checked,  signed,  and  the  seal  affixed  by  the  cor- 
poration, and  then  certified  by  the  trustee,  they  are  returned 
to  the  issuing  corporation  who  turns  them  over  to  the  banker  to 
be  sold. 

Distribution  of  Corporate  Securities. — There  are  three  gen- 
eral methods  for  the  distribution  of  corporate  securities.  The 
first  method  is  by  allotment  to  the  present  security  holders, 
usually  at  a  lower  price  than  the  existing  market  price.  This 
method  is  more  frequently  used  in  the  distribution  of  common 
stocks,  than  either  preferred  stocks  or  bonds.  In  the  issuance 
of  bonds,  this  method  is  used  only  where  the  company  has  either 
become  involved  and  the  securities  would  have  to  be  marketed  at 
a  great  sacrifice,  or  where  it  desires  to  give  the  existing  holders 
the  advantage  of  securing  additional  holdings  in  the  company. 
The  former,  of  course,  does  not  concern  us  in  a  study  of  invest- 
ment securities,  except  as  it  illustrates  what  the  investment  pur- 
chaser should  avoid.  The  latter  is  more  frequently  practiced 
by  small  and  closely  controlled  corporations,  though  subscrip- 
tions are  now  frequently  given  in  all  classes  of  corporations. 

The  second  method  of  selling  securities  directly  to  the  public 
is,  like  the  former  method,  handled  exclusively  by  the  corpora- 
tion. This  method  has  also  been  used  by  a  few  of  the  munici- 
palities. Only  in  rare  cases  of  small  issues,  in  a  local  market, 
has  it  been  successful.  "Where  the  issue  is  too  small  to  bear  the 
expense  of  the  investigation  and  underwriting,  the  corporation 
is  compelled  to  sell  its  own  issues,  though  neither  corporations 
nor  municipalities  have  the  selling  organization  that  make  quick 
sales  possible.  There  are  few  undertakings  of  either  a  corpo- 
rate or  municipal  character  which  can  advantageously  use  funds 
that  are  received  over  a  long  period  of  time  and  in  small 


NEGOTIATION  AND  ISSUANCE  101 

amounts.  Permanent  improvements  call  for  contracts  with 
large  immediate  outlays.  A  few  isolated  cases  of  the  sale  of 
municipal  securities  over  the  counter  of  a  municipal-treasurer 
have  met  with  success  and  resulted  in  a  saving  of  considerable 
expense.  The  successful  attempts  in  this  method  of  marketing 
are,  however,  too  few  to  prove  anything.  In  the  majority  of 
instances,  it  has  turned  out  to  be  a  costly  method  of  distribu- 
tion. 

The  most  economical,  consequently  the  most  effective,  form 
of  distribution  as  yet  devised,  is  to  have  some  banker  or  group  of 
.bankers  underwrite  the  issue.  When  an  individual  bank  carries 
on  the  transaction,  the  sale  is  then  made  by  the  corporation  or 
civil  division  to  the  bank,  which  sells  them  directly  to  the  public, 
through  its  own  sales  organization.  The  listing  and  sale  of 
securities  on  the  stock  exchange  is  usually  not  made  until  at 
least  a  majority  of  the  original  securities  have  been  sold.  When 
either  a  single  bank  underwrites  and  redistributes  to  a  group 
of  bankers  or  a  group  of  bankers  assume  an  equal  interest  in 
the  issue,  the  underwriting  is  termed  syndicate  underwriting. 
The  purpose  of  the  latter  method  is  to  distribute  the  risk,  that 
is,  it  is  an  insurance  against  any  direct  loss  from  being  com- 
pelled to  carry  the  securities  for  too  long  a  period — but  more 
especially,  it  eliminates  the  risk  of  selling  by  securing  a  wider 
market  and,  consequently,  quicker  sales. 

An  underwriting  by  a  banker  insures  the  selling  of  the  secu- 
rities of  a  municipality  or  corporation,  and  allows  the  munici- 
pality or  corporation  making  the  issue  to  proceed  with  its 
expansion  or  construction  plans  without  the  possibility  of  any 
delays.  The  investment  banker  is  enabled  to  advance  the 
money,  as  he  can  use  the  securities  being  offered  for  sale  as 
collateral  for  loans.  A  long  delay  in  the  sale  of  securities  will 
seriously  impair  a  corporation's  credit.  The  underwriting  also 
gives  the  corporation  or  municipality  the  advantage  of  the 
banker's  experience  in  avoiding  mistakes  in  legality,  validity, 
form  of  issue,  price,  etc.,  of  the  security  issued — matters  all  of 
which  are  to  the  advantage  of  the  purchaser. 

There  are  four  types  of  syndicating  used.  The  first  three 
are  based  on  direct  purchase ;  the  fourth,  which  has  practically 


102  INVESTMENT  ANALYSIS 

been  discarded,  provides  for  a  guarantee  of  sale.  The  most 
common  method  now  used  is  an  agreement  between  the  syndi- 
cate and  the  corporation  by  which  the  members  of  the  syndicate 
receive  directly  the  allotment  of  securities  which  they  have 
agreed  to  sell.  Each  member  then  proceeds  to  resell  his  securi- 
ties on  any  plan  he  chooses  to  follow,  independent  of  the  syndi- 
cate. No  agreement  of  the  syndicate,  however,  such  as  not  to 
change  the  price  agreed  upon  can  be  violated  by  an  individual 
member  of  the  syndicate.  A  second  type,  sometimes  called  joint 
account1  as  opposed  to  the  joint  syndicate,  is  an  agreement 
between  a  single  banking  house  and  a  corporation.  The  bank 
then  induces  other  banking  houses  to  take  a  portion  of  the 
securities,  and  the  bank  thus  reduces  its  own  risk.  In  the  third 
form  of  syndicate,  the  agreement  is  made  between  the  syndicate 
and  the  corporation.  One  member  of  the  group  is  made  syndi- 
cate manager,  usually  the  house  originally  interested  in  forming 
the  syndicate.  In  a  number  of  these  syndicates,  no  actual  dis- 
tribution of  the  securities  has  been  made  until  at  least  a  major 
portion  of  the  issue  has  been  sold.  The  fourth  type  of  guaran- 
tee of  the  sale,  is  the  older  and  original  method  of  syndication 
practiced,  which  is  now  rarely  used.  The  banker  either  guaran- 
tees the  sale  of  the  securities  at  a  price,  or  if  the  securities 
are  not  all  sold  at  a  given  date,  he  agrees  to  take  the 
balance  at  a  stated  price,  which  usually  is  lower  than  the 
original  price  paid.  This  allows  the  corporation  to  use  its 
discount  privileges,  if  it  so  desires,  on  these  unsold  securities. 
It  is  in  the  understanding  of  the  market  that  a  banker's  office 
can  render  valuable  service  to  the  corporation.  A  security 
that  does  not  find  an  immediate  market  is  quite  likely  to  impair 
seriously  the  corporation's  credit,  as  well  as  involve  consid- 
erable direct  financial  loss. 

Syndicate  agreements  are  formally  drawn  up  and  signed  by 
the  participating  members.  In  small  syndicates  the  agreement 
is  not  infrequently  made  orally.  The  main  syndicate  agree- 


'Hastings  Lyon,  Special  Report  on  Joint  Account  Letters  and  Forms 
end  Some  Considerations  of  the  Law  of  Joint  Account  to  the  Investment 
Bankers'  Association  contains  an  excellent  statement  on  the  Joint  Ac- 
count. (In  I.  B.  A.  Bulletin.) 


NEGOTIATION  AND  ISSUANCE  103 

ments  include:  (1)  a  brief  statement  of  the  requirements  which 
the  member  must  fulfill;  (2)  the  limit  of  the  member's  liability 
to  the  amount  he  subscribes;  (3)  a  brief  description  of  the 
security;  (4)  the  details  of  management,  and  (5)  a  statement 
of  prices,  etc.,  and  the  duration  of  the  syndicate.  If  the  syn- 
dicate has  not  completed  the  sale  of  its  securities  within  the 
allotted  time,  provisions  are  usually  made  for  its  extension.  A 
few  syndicates  have  lasted  for  several  years.  Informal  as  some 
of  the  syndicate  agreements  have  been,  there  is  seldom  ever  any 
disagreement  that  leads  to  litigation. 

Commissions  to  the  banker  for  conducting  the  syndicate  vary 
widely.  As  the  commission  ascends,  the  chances  are  that  the 
security  enters  to  an  equivalent  degree  into  the  speculative 
class.  This  is  especially  true  where  bonuses  are  given  to  the 
syndicate.  Additional  profits  are  sometimes  realized  by  mem- 
bers of  a  syndicate  when  the  securities  are  all  taken  up  and 
temporarily  held  for  a  better  market.  The  large  carrying 
charge  seldom  warrants  this,  except  in  speculative  under- 
writings. 

A  very  small  proportion  of  bonds  issued  are  bought  and  sold 
on  the  exchange,  though  there  are  a  considerable  number  of 
issues  listed.  The  permanency  in  the  large  holdings  of  bonds 
also  leaves  only  a  small  ratio  of  bonds  which  reappear  on  the 
exchange.  It  has  been  estimated  that  only  about  one-tenth  of 
the  Government  bonds  sold  prior  to  the  War  passed  through  the 
exchange.  Where  syndicates  are  formed  for  the  distribution 
of  state  and  municipal  securities,  the  procedure  of  organization 
is  similar  to  that  used  in  some  of  those  organized  for  under- 
writing corporation  securities,  and  needs  no  further  comment. 
Because  of  these  conditions,  there  is  little  object  in  listing  any 
of  the  smaller  issues. 

This  latter  situation,  especially,  necessitates  that  the  banker 
shall  sustain  a  market  for  the  securities  which  he  has  under- 
written, or  offered  for  sale.  Not  infrequently  the  purchaser  of 
a  bond,  who,  at  the  time  he  bought  the  bond,  had  no  intention 
of  selling,  is  forced  to  dispose  of  it.  The  banker,  in  order  to 
maintain  the  highest  reputation  for  his  securities,  must  either 
create  or  provide  a  market  for  these  securities.  If  the  holder, 


104  INVESTMENT  ANALYSIS 

who  naturally  turns  to  the  banker  who  offered  the  securities, 
cannot  find  a  market  with  the  latter,  he  will  be  forced  to  throw 
it  on  the  market  at  a  very  large  sacrifice  even  though  the 
underlying  value  is  sound.  In  this  very  legitimate  practice 
of  providing  a  market,  the  banker  is  performing  a  valuable 
service,  not  only  to  himself,  but  to  the  corporation  and  the 
investor.  As  referred  to  elsewhere,  this  legitimate  sustaining 
of  a  market  must  be  distinguished  from  a  market  which  is  sus- 
tained for  the  purpose  of  hiding  a  weak  corporation.  Bankers 
of  doubtful  repute  have  been  known  to  force  up  the  price  of 
some  of  their  offerings  in  their  own  office,  five  to  ten  points  over 
night,  but  these  were  speculative  securities,  and  not  investments. 

When  the  offering  is  large  and  widely  held,  an  active  market 
is  automatically  established  and  the  banker  will  not  have  to  sus- 
tain the  market,  except  where  a  corporation  has  come  into  a 
weakened  condition.  If  this  condition  is  only  temporary,  it 
need  not  give  the  holder  of  an  investment  security  any  concern. 
If  it  is  a  permanent  change,  then  the  holder  of  these  securities 
should  closely  watch  the  corporation's  condition,  as  any  sustain- 
ing of  the  market  is  fictitious.  When  the  issue  is  small  or  inac- 
tive, a  forced  reappearance  of  some  of  the  bonds  on  the  market 
may  cause  a  depression  of  the  price  though  the  corporation's 
condition  may  have  been  materially  strengthened  since  the  orig- 
inal issue.  It  is  quite  evident  that  unless  the  banker  does 
provide  for  a  market  for  these  securities  which  are  sold 
again,  all  interests  must  suffer  a  loss  despite  the  character  of 
the  security. 

Lastly,  a  new  type  of  agreement  which  cannot  yet  be  said 
to  be  established  is  developing ;  namely,  the  relationship  between 
the  bond  departments  of  banks  in  large  cities  and  the  banks  of 
small  cities  and  towns.  While  it  is  true  that  this  practice  has 
already  been  established,  it  is  relatively  as  yet  very  insignificant. 
New  sources  of  capital  for  the  commercial  and  industrial  devel- 
opment must  be  secured.  Why  go  abroad  if  it  can  be  secured 
within  our  own  borders?  Some  of  the  agricultural  states,  for 
example,  of  the  Middle  West  now  accumulate  surplus  funds 
every  year.  The  most  economical  method  by  which  these  funds 
can  be  secured  is  through  the  local  banks  of  the  territory.  The 


NEGOTIATION  AND  ISSUANCE  105 

banks  know  who  possess  funds  and  the  expense  of  this  selling 
method  in  rural  territory  would  be  more  economical  than  the 
employment  of  special  salesmen  to  sell  direct  to  individuals  by 
city  banks.  While  a  small  commission  is  now  allowed  these  so- 
called  small  city  and  country  banks,  in  the  very  near  future, 
the  stronger  of  these  small  banks  or  a  number  of  them  together 
are  going  to  demand  a  certain  participation  in  the  syndicate. 
How  soon  this  will  take  a  more  definite  form  or  what  the  defi- 
nite form  will  be,  it  is  too  early  to  say.  There  is,  however,  no 
question  that  this  demand  is  now  beginning  to  take  a  definite 
form.1 

Distribution  of  Civil  Loans. — The  Federal  Government  dur- 
ing the  War  gave  up  the  sale  of  its  bond  issues  by  syndicates.* 
Prior  to  the  European  War,  announcement  of  a  loan  was  pub- 
licly made  by  the  Treasury  Department,  and  bids  requested. 
Subscription  blanks  were  filled  out  and  a  cash  deposit  required, 
except  in  a  few  instances  where  the  market  would  have  been 
greatly  affected.  After  the  bids  were  closed,  the  list  of  the 
subscribers  allotted  their  subscriptions  was  sent  out.  Tempo- 
rary certificates  were  given  with  the  final  payment  of  the  sub- 
scription. The  subscription  to  the  Liberty  Loans  was  some- 
what different.  The  huge  sums  needed  necessitated  organized 
campaigns  with  which  all  are  so  familiar  that  it  is  not  essen- 
tial to  give  the  details.  All  subscriptions  of  small  amounts 
were  allotted  for  the  purpose  of  popularizing  the  loans. 

The  states  follow  much  the  same  method  as  that  formerly 
employed  by  the  Federal  Government,  in  requiring  the  submis- 
sion of  sealed  bids.  While  in  the  main  this  is  also  the  method 
of  the  minor  civil  divisions  of  the  state,  the  actual  practice 
varies  between  civil  divisions  in  the  same  state,  except  where 


Another  form  of  marketing  securities  which  has  been  used  by  a 
few  public  utility  corporations,  is  the  selling  of  securities  directly  to  their 
own  customers.  This  practice  possesses  large  possibilities  and  will 
increase.  It  also  has  the  advantage  of  closer  co-operation  between  the 
public  utility  and  the  public  which  is  of  paramount  importance  to  any 
utility  company. 

"The  Federal  Farm  Loan  Bank  bonds  issues  and  the  issues  of  the 
Joint  Land  Bank  organized  under  the  Federal  Act  have  all  been  under- 
written by  private  bankers,  but  they  cannot  be  considered  as  direct 
issues  of  the  Federal  Government. 


106  INVESTMENT  ANALYSIS 

statutes  require  uniform  procedure.  The  listing  on  the 
exchange  is  not  done,  as  a  rule,  until  the  major  part  at  least 
of  the  underwriter's  original  offerings  have  been  marketed.  It 
is  always  necessary  that  an  investment  banker  protect  his 
market  against  the  speculator  during  the  period  of  original  sale. 
Any  movement  started  at  this  time  that  would  move  the  price  a 
fraction  below  the  offering  price  of  the  underwriters,  would 
destroy  the  market  for  the  latter.  And  this  depression  in  price 
might  be  effected  by  the  speculator  in  trading  purchases  which 
would  not  necessarily  be  any  reflection  upon  the  original  price 
made  to  the  public. 

Mr.  Hastings  Lyons  explains  the  method  of  creating  a 
market  for  listed  securities  as :  "  Building  a  market,  in  the  sense 
of  establishing  a  course  of  trading  is  much  like  building  an 
arch ;  if  the  process  is  complete,  the  market  will  support  itself. 
A  buying  demand  will  exist  sufficient  to  meet  without  break- 
down any  pressure  to  sell.  The  bankers  who  brought  out  the 
issue  can  now  welcome  the  speculators;  every  speculative  pur- 
chase and  sale  means  one  more  transaction  to  help  make  the 
market  more  active  and  therefore  more  stable. ' '  * 

"When  bids  are  made  by  a  bank  for  a  civil  division  issue, 
they  are  made  either  in  whole  or  part.  A  bid  is  frequently 
made  by  a  banker  with  the  qualifications  that  the  bid  is  made 
only  for  the  whole  of  the  issue  or  a  particular  portion  of  it. 
The  highest  bidder  receives  the  allotment,  if  all  the  require- 
ments of  the  advertisement  have  been  fulfilled,  though  the 
highest  price  bid  for  a  portion  of  the  issue  might  not  be  taken, 
as  the  remainder  might  have  to  be  sold  at  such  a  price  that 
the  total  net  price  would  be  lower  than  if  a  lower  price 
were  taken  for  the  total  block  of  bonds.  Bankers  also  some- 
times give  different  bids  for  various  amounts  of  the  issue. 
Bids  must  usually  be  accompanied  with  a  deposit  and  be  sealed. 
If  an  allotment  is  made  and  the  bidder  fails  to  take  it  up,  his 
deposit  is  forfeited.  On  the  other  hand,  the  bid  is  always 
qualified  by  the  provision  that  the  issue  has  met  all  legal  require- 
ments. A  few  issues  have  been  sold  directly  to  the  public  by 


'Hastings  Lyon,  Corporation  Finance,  Part  II,  p.  160  (1916). 


NEGOTIATION  AND  ISSUANCE  107 

the  officials  of  the  municipality.  This  is  still  of  infrequent 
occurrence  and  has  not  always  been  successful. 

When  the  award  has  been  made  the  proper  officials  of  the 
civil  division  submit  a  complete  set  of  transcripts  to  the  bank 
allotted  the  bonds.  These  transcripts  should  contain  every  step 
taken  in  marketing  the  loan  up  to  the  actual  awarding  of  the 
bonds.  When  the  legality  of  the  bonds  has  been  approved  by 
the  counsel  of  the  bidder,  they  are  then  accepted  and  the  official 
imbursed  for  the  bid.  As  approximately  twenty-five  per  cent  of 
the  civil  loan  issues  originally  bid  for  are  rejected,  because  of 
legal  irregularity,  the  importance  of  this  qualification  is 
apparent. 

New  York  Stock  Exchange  Rules  for  Listing.1 — One  of  the 
most  effective  forms  of  legal  protection  in  forcing  the  proper 
issuance  of  the  mortgage  and  bond,  has  been  the  Listing  Rules 
of  the  New  York  Stock  Exchange.  While  the  direct  purpose 
of  the  Exchange  has  been  to  insure  perfect  freedom  and  safety 
in  trading,  the  protection  given  the  security  has  been  no  less 
important. 

The  more  important  of  the  advantages  in  listing  are  the 
wider  and  freer  market,  greater  stabilization  of  the  price  of  the 
security,  greater  convertibility  and  wider  and  cheaper  hypothe- 
cation. Incidentally,  with  these  advantages,  are  procured 
additional  sanctions  as  to  the  legality  and  certification  of  the 
mortgages  and  bonds,  together  with  certain  public  corpora- 
tion reports.  An  even  more  important  protection — one  against 
fraud — exists  in  the  exact  regulations  which  the  members 
must  meet  in  dealing  with  their  customers.  No  less  important 
is  the  stabilization  it  creates  for  securities  in  the  privilege  it 

irThe  New  York  Stock  Exchange  Rules  for  Listing  are  given  in 
preference  to  any  other  of  the  Stock  Exchange  Rules,  because  of  the 
large  number  of  securities  listed.  The  rules  of  the  other  Exchanges 
have  been  closely  modeled  after  those  of  the  New  York  Stock  Exchange. 

For  complete  description  of  listing  and  stock  exchange  transactions 
see  the  following:  Hearings  before  the  Senate  Committee  on  Banking 
and  Currency,  S.  3895,  63d  Congress.  Second  Session;  Sereno  S.  Pratt, 
Work  of  Wall  Street  (Revised,  1920)  ;  W.  C.  Van  Antwerp,  The  Stock 
Exchange  from  Within  (1919)  ;  S.  S.  Huebner,  "The  Scope  and  Functions 
of  the  Stock  Market,"  The  Annals  of  American  Academy  of  Political  and 
Social  Science,  vol.  xxxv  (May?  1910),  pp.  1-23.  (See  index  of  same 
volume  for  other  articles. ) 


108  INVESTMENT  ANALYSIS 

permits  for  more  easily  discounting  the  future  and  the  creation 
of  a  constant  flow  and  outlet  for  corporation  capital.  These 
rules  directly  affecting  the  security,  whose  compliance  must 
meet  the  approval  of  the  Listing  Committee,  are  summarized  as 
follows : 

The  papers  to  be  filed  with  the  application  for  listing,  prob- 
ably give  the  most  comprehensive  view  of  the  requirements  of 
this  Committee.1 

(1)  The    instrument    or    instruments     representing    the 
rights  of  the  holder  must  contain  a  complete  recital  of  these 
claims.     Seven  copies  of  the  mortgage  are  to  be  filed,  one  to 
be  certified  by  the  Trustee.     Rights  of  registration,  transfer, 
conversion  and  interchange   of   bonds,   whether  registered   or 
coupon  bonds,  general  statement  of  lien,  the  amount  of  the  issue, 
the  dates  and  parties  of  issue,  denomination,  rate  of  interest,  any 
sinking  fund  provisions,  any  convertible  privileges,  the  time,  the 
place,  notices  and  conditions  of  redemption  are  to  appear  on 
the   bond.     The   power   of   assignment,    according   to    a   form 
approved  by  the  Committee,  must  be  given  for  registered  bonds. 
When  interchangeable,  the  rules  state:  "When  a  mortgage  or 
indenture  provides  that  bonds  may  be  issued  interchangeably  in 
coupon  and  registered  form,  each  registered  bond  issued  there- 
under shall  bear  a  legend  reciting  the  number  or  numbers  of  the 
coupon  bond  or  bonds  reserved  for  exchange  of  such  registered 
bond."    When  coupon  bonds  are  issued  in  denominations  of  less 
than   $1,000,    and   they   are   exchangeable   for   $1,000   coupon 
bonds,  the  smaller  bonds  should  contain  the  legend  granting 
this  privilege.     They  are  further  designated  by  a  serial  number. 

(2)  The  Listing  Committee,  in  order  to  have  some  proof 
of  the  legality  of  the  issue  requires  an  opinion  of  the  applicant's 
counsel  as  to:    (a)  organization,  and  (b)  validity  of  the  issue; 
(c)  all  the  papers  covering  the  authorization  of  the  issue;  (d) 
the  certificates  of  the  public  authority;   (e)   certificate  of  the 
registrar's  present  registration. 

(3)  The  committee  recommends  that  a  different  trustee  be 
appointed  for  each  indenture,  though  this  has  not  been  enforced 


'See  Stock  Exchange  Listing  Rules  for  complete  details  of  the  Com- 
mittee's  regulations. 


NEGOTIATION  AND  ISSUANCE  109 

where  impractical,  as  in  consolidations  and  mergers.  No  official 
or  representative  of  a  corporation  shall  be  made  a  trustee  for 
the  company's  own  mortgage.  The  trustee's  certificate  shall 
cover:  (a)  the  acceptance  of  the  trusteeship,  (b)  "the  issuance 
under  the  terms  of  the  mortgage  or  indenture  with  the  number, 
amount,  etc.,  of  securities  held,  and  (c)  the  cancellation  or  cre- 
mation of  deposits  of  underlying  securities  prior  liens,  etc.," 
and  (d)  a  copy  of  the  resolutions  covering  the  appointment  of 
the  transfer  agent  and  registrar. 

(4)  The  mortgage  instrument,  in  addition  to  the  details 
included  in  one,  two  and  three,  must  include  a  detailed  descrip- 
tion of  the  lien  approved  by  the  Committee;  this  description 
covers  franchises,  land,  buildings,   equipment,  right  of  ways, 
leases,  other  privileges,  titles,  guarantees,  etc. 

(5)  When  a  corporation  applies  for  listing  its  securities,  it 
must  agree:  to  dispose  of  any  of  its  property  only  on  authori- 
zation of  the  stockholders;  to  make  an  annual  report  fifteen 
days  before  the  annual  meeting  of  the  stockholders,  to  maintain 
a  transfer  and  registry  office  or  agency  in  the  Borough  of  Man- 
hattan, New  York  City;  to  give  ten  days  for  the  closing  of  the 
books;   and  to  notify  the  Stock  Exchange  of  any  rights   or 
issuance  of  rights  or  subscriptions. 

(6)  The  Committee  requires  that  bonds  and  coupons  shall 
be  printed  by  an  engraving  company  approved  by  it,  accord- 
ing to  specified  rules. 

(7)  In  addition  to  these  conditions,  other  important  require- 
ments   are    statements    of:    the    purpose    of    listing,    a    report 
covering  all  the  details  of  the  corporation's  charter,  original 
organization,   character  of  business,    and  subsequent  financial 
history,  including  details  of  any  reorganization  and  practices, 
or  mergers;  its  present  financial  status;  a  complete  description 
and  engineer's  report  on  its  physical  properties;  detailed  char- 
acter of  its  liabilities;  details  of  contracts  with  other  corpora- 
tions or  individuals;  names  of  the  officials  and  transfer  agents, 
trustees,  and  registrars:  location  of  its  offices,  time  of  meet- 
ings, etc. 


The  mortgage  is  defined  as  the  instrument  which  secures 
the  principal  and  interest  of  the  bonds  by  pledging  specified 
property.  It  may  cover  property  to  be  acquired,  and  the  gen- 
eral assets  of  the  corporation.  It  usually  is  in  the  form  of  a 
conveyance  to  a  trustee  and  is  known  in  that  case  as  a  trust 
deed.  The  bonds  are  described  in,  and  secured  by  the  mortgage 
or  trust  deed,  and  thus  become  the  legal  representations  (i.  e.  of 
the  bondholders'  claims)  of  the  rights  stipulated  in  the  mort- 
gage or  trust  deed.  In  any  variation  between  the  two  instru- 
ments, the  bond  has  precedence,  as  the  mortgage  or  trust  deed 
is  dependent  on  the  bond  and  can  have  no  existence  except  as 
security  therefor.  In  this  connection,  it  must  be  recalled  that 
by  the  common  law  a  note  or  bond  was  negotiable,  while  the 
trust  deed  was  not  negotiable,  with  the  result  that  in  a  suit  upon 
the  debt  in  the  law  courts  by  holders  in  due  course,  defenses 
could  not  be  interposed  against  such  holders,  which  could  be 
interposed  against  them  in  a  foreclosure  proceedings  under  the 
mortgage.  This  undesirable  situation  of  the  common  law  has 
been  quite  generally  altered  by  legislation  to  the  effect  that 
when  any  negotiable  instrument  is  secured,  defenses  cannot  be 
set  up  in  a  suit  upon  the  security  which  could  not  be  made  in 
a  suit  on  the  debt. 

The  issuance  of  this  intermediate  instrument  grew  out  of  a 
practical  and  not  a  legal  necessity.  With  the  growth  of  cor- 
porations, the  amount  of  money  needed  was  more  than  one  indi- 
vidual could  advance,  or,  if  he  had  sufficient  capital  for  the 
smaller  corporation,  he  was  not  willing  to  take  the  risk  of 
investing  all  of  his  funds  in  one  enterprise.  To  give  a  frac- 
tional claim  of  a  railroad 's  mileage  as  security  for  a  bond  would 
be  futile  to  both  the  railroad  and  the  bondholder.  The  issu- 

110 


Ill 

ance  of  a  mortgage  in  security  for  an  advancement  of  all  funds 
wanted  by  the  corporation  and  creation  of  a  trustee  to  act  for 
all  bondholders  did  make  possible  the  issuance  of  fractional 
claims  against  this  mortgage,  while  at  the  same  time  it  consoli- 
dated all  claims  through  the  assignment  of  the  mortgage  to  a 
trustee.  This  made  possible  unified  action,  and  gave  some  value 
to  the  bondholders'  claim,  and  also  protected  the  corporation. 

The  mortgage,  after  it  has  been  legally  authorized,  is  a 
pledge  by  the  corporation  of  its  property,  which  gives  the  right 
to  advance  funds  to  the  corporation  and  to  seize  the  property 
upon  failure  of  the  payment  of  the  principal  and  interest  when 
due.  The  bonds  then  are  merely  evidences  of  this  obligation 
and  the  promise  of  the  corporation  to  pay. 

Limitations  of  Issue.1 — The  older  practice  in  marketing  mort- 
gage and  bond  issues  was  to  make  an  issue  to  meet  the  immedi- 
ate needs,  though  most  of  the  older  statutes  permitted  many 
of  the  modern  practices.  The  more  recent  statutes  and  prac- 
tices are  tending  to  a  more  elastic,  yet  safer  policy — safer  if  the 
proper  control  of  the  issuance  is  exercised.  Where  liberaliza- 
tion is  extended  which  results  in  larger  advantages  to  the  cor- 
porations the  danger  always  exists  that  adequate  provisions  will 
not  be  made  to  safeguard  the  investor. 

Three  general  classifications  that  may  be  made  of  mortgages 
for  legal  identification  are:  (a)  the  closed-end  mortgage;  (b) 
the  open-end  mortgage;  and  (c)  the  open  mortgage.  The 
closed-end  mortgage  provides  for  the  issuance  of  a  limited 
amount  which  is  issued  all  at  once.2  This  is  an  older  form  which 
gained  such  favor  at  one  time  that  all  other  issues  were  dis- 
carded; it  was  then  rejected  for  a  period  and  again  revived, 
but  is  now  rapidly  passing  out  of  use.  A  good  example  of 
the  older  use  of  these  mortgages  are  the  liens  issued  on  the  Erie 
Railroad  between  Jersey  City,  New  Jersey,  and  Dunkirk,  New 
York.  Nine  bonds  issued  by  this  method,  upon  this  particu- 


JAs  the  Authorization  of  the  Issue  has  been  treated  in  a  preceding 
chapter,  it  is  not  considered  necessary  to  repeat  it  here,  though  it 
should  also  be  considered  at  this  point. 

'Mortgages  under  the  above  titles  are  often  differently  described, 
and  the  reader  in  making  comparisons  with  other  authors  should  bear 
this  fact  in  mind. 


112  INVESTMENT  ANALYSIS 

lar  mileage,  are  still  extant.1  In  the  open-end  mortgage,  the 
amount  is  fixed  but  is  issued  in  stated  or  varying  amounts, 
and  under  conditions  agreed  upon  in  the  mortgage,  which  are 
generally  the  same  as  in  the  open-mortgage. 

The  open-mortgage2  has  no  limitation  as  to  the  amount  that 
may  be  issued  except  the  agreements  in  the  mortgage  itself  and 
the  statutory  limitations  of  the  particular  state  in  which  issued. 
These  issues  are  still  rare,  but  with  the  increasing  state  regula- 
tion of  security  issues,  they  are  the  logical  development,  at  least 
for  large  corporations.  For  why  should  a  company  be  continu- 
ally asking  for  new  issues  if  the  maximum  increase  is  fixed  at 
two-thirds  or  three-fourths  of  the  new  extension  or  addition, 
and  interest  charges,  including  the  interest  on  the  new  issues, 
must  be  earned  from  one  and  one-half  to  three  times  and  the 
certification  of  the  fulfillment  of  these  requirements  has  been 
guaranteed  by  the  trustees?  The  serious  criticism  which  has 
been  made  against  this  method,  and  rightly  so,  is  the  fact  that 
the  practice  of  evaluating  and  auditing  the  additions  to  the 
physical  plant  and  equipment  is  not  always  carefully  carried 
out  by  the  trustee.  In  practice,  very  frequently  the  trustee 
accepts  the  statements  of  the  issuing  corporation  without  himself 
providing  for  a  complete  and  proper  checking  of  the  properties. 
Greater  guarantee  of  more  complete  auditing  must  be  insisted 
upon  before  this  type  of  issue  can  be  fully  accepted  by  the 
investor.  Where  this  condition  is  met,  the  advantages  accruing, 
both  to  the  investor  and  the  corporation,  are  greater  than  with 
any  other  type  of  issue,  and  sooner  or  later  these  protections 
will  be  incorporated  in  mortgages. 

The  statutes  sometimes  designate  the  amount  of  bonds  that 
may  be  issued  upon  a  property.  The  most  common  limitations 
are  those  stipulating  the  ratio  of  bonded  debt  to  capital  stock 
and  of  the  bonded  debt  to  the  value  of  the  fixed  property.  The 
total  amount,  where  a  limit  is  placed  on  the  issue,  should  be 


'On  date  of  January  1,  1920. 

'The  strictly  open-mortgage  (or  "open-issue")  allows  the  further 
issue  of  bonds  with  the  same  lien  as  the  bonds  outstanding,  so  in  a 
receivership  all  bonds  put  out  at  various  times  are  on  the  same  basis. 
In  practice,  however,  certain  values  in  property  must  exist  as  stated 
above.  This  technically  does  place  a  limitation  on  the  issue. 


113 

given  in  the  mortgage.  This  does  not  mean,  however,  that  all 
the  bonds  shall  be  issued  at  one  time.  The  terms  of  the  mort- 
gage may  designate  that  the  whole  or  any  part  shall  be  issued 
at  a  given  time,  or  a  part  may  be  retained  to  retire  existing 
issues  that  mature  at  a  later  date.  Almost  any  method  of  legit- 
imate issue  may  be  used  as  long  as  it  comes  within  the  limits  of 
the  authorization.  Bonds  put  out  in  excess  of  the  amount  fixed 
by  statute  are  illegally  issued  and  consequently  void.  If  the 
amount  issued  is  not  in  excess  of  the  amount  stipulated  by  the 
mortgage,  the  bondholders  have  a  legitimate  claim  against  the 
corporation  on  an  equal  basis  with  the  other  bondholders. 

General  Provisions  in  the  Corporate  Mortgage  Instrument. — 
Though  the  exact  provision  in  the  particular  mortgage  must 
differ,  the  general  provisions  have  been  so  well  standardized 
that  they  apply  to  all  mortgages.  They  are  as  follows : 

1.  The  date  of  the  issue  of  the  mortgage  is  given; 

2.  The  parties — who  are  the  corporation  as  party  of 
the  first  part,  and  the  trustee  or  trustees  who  are  parties 
of  the  second  part  and  who  hold  the  title  for  the  bond- 
holders1— are  named. 

3.  The  preamble  recites  the  legal  status  of  the  cor- 
poration; namely,  the  state  in  which  it  is  incorporated, 
and  whether  organized  under  special  or  general  laws  of 
the  state,  by  consolidation  or  other  form ;  its  domicile ;  its 
capitalization ;  and  the  properties  owned  and  leased  when 
included  in  the  mortgage.     The  purposes  for  which  the 
proceeds  of  the  bond  issue  are  to  be  used  are  set  forth, 
together  with  the  promise  to  pay  the  amount  of  the  issue, 
limitations,  and  protection  against  over-issue. 

4.  A  copy  of  the  stockholders'  resolutions2  and  the 
directors'   resolutions   approving  the  issue  is   included 
here,  and  it  should  specify  the  officer  or  officers  who  are 
authorized  to  execute  the  same.     In  some  states  there  is 
added  the  authority  of  a  state  commission  for  public  utili- 
ties, and  it  is  well  to  include  before  the  grant,  a  clause 

'The  rules  of  the  New  York  Stock  Exchange  require  that  no  officer 
or  director  of  the  corporation  can  act  as  a  trustee.  Because  of  the 
variations  in  the  state  laws,  which  limit  the  rights  of  trustees  in  their 
jurisdiction  of  foreign  corporations,  in  many  states,  where  it  is  neces- 
sary to  insure  against  complication  with  a  state  over  its  trusteeship 
laws,  it  is  well  to  appoint  a  co-tcnstee  to  act  with  the  trustee. 

"Most  of  the  states  require  a  two-thirds  vote  of  stockholders  to 
approve  the  authorization. 


114  INVESTMENT  ANALYSIS 

stating  that  all  the  requirements  of  the  law  in  respect  to 
the  mortgage  and  bonds  have  been  complied  with  in  mak- 
ing this  issue.  The  amount,  rate,  maturity,  denomina- 
tions and  whether  interchangeable,  endorsement,  registra- 
tion, transfer,  replacements,  execution,  etc.,  are  also 
included. 

5.  The  full  text  of  the  bond,  an  exact  copy  of  the 
interest  coupon,  the  form  of  the  trustee  certificate,  and 
the  form  of  guarantee,  if  given,  and  signatures,  etc.,  are 
presented. 

6.  A  description  of  the  conveyance  of  the  property 
that  is  pledged  to  the  payment  of  the  bond  issue  is  given 
in  detail — "the  mortgaged  premises,  generally  acknowl- 
edging a  nominal  consideration  paid  by  the  trustee  to  the 
corporation  and  reciting  the  further  consideration,"  etc.1 

7.  A  complete  and  detailed  description  of  the  prop- 
erty, including  franchise,  patent  rights,  trade-marks,  etc., 
is  set  forth.     If  stocks,  mortgages,  patent  rights,  trade- 
marks, etc.,  exist,  they  are  set  forth,  and  the  corporation 
will  execute,  simultaneously  with  the  execution  of  the 
mortgage,  to  a  trustee.     If  other  liens  already  exist  on 
the  same  property,  they  should  be  stated  with  their  priori- 
ties and  position,  as  well  as  the  liens  of  subsidiary  com- 
panies. 

8.  Following  the  description  of  the  property,  a  great 
many   mortgages    now    contain    the    so-called   unlimited 
amount,   or  after-acquired  property   clause,   which  pro- 
vides for  the  inclusion  of  any  property  that  the  company 
might  develop  or  acquire  in  the  future,  during  the  life  of 
the   mortgage,    after    the    corporation    has   met    certain 
requirements   specified  in   the  mortgage.     Usually  new 
bonds,  under  the  authorization,  can  be  issued  up  to  a 
given  per  cent  of  the  value  of  the  property.     In  public 
utilities  this  is  from  two-thirds  to  three-fourths  of  the 
value  of  the  property,  with  the  additional  requirement 
that  the  interest  charge  be  earned  a  stated  number  of 
times. 

9.  A  statement  of  the  acceptance  of  the  mortgage 
and  the  trustees'  duties,  rights,  and  obligations,  and  pro- 
vision for  his  certification  and  the  agreement  of  the  cor- 


JThe  trustee  merely  holds  the  property  and  exercises  control  in 
behalf  of  the  bondholders  under  the  mortgage.  If  the  conveyance  is  in 
the  form  of  such  collateral  as  stocks  and  bonds,  they  are  delivered  to 
the  trustee.  The  voting,  payment  of  dividends,  etc.,  are  provided  for 
in  the  mortgage. 


COKPOKATION  MORTGAGE  115 

poration  to  convey  the  mortgage  to  a  trustee  are  also 
included. 

10.  A  covenant  by  the  company  to  pay  the  principal 
and  interest  when  due  under  specified  conditions  stated 
in  the  mortgage  is  given. 

11.  Provisions  are  made  for  the  place,  method  and 
medium  of  payment  and  the  registration  and  transfer, 
number,  signature  and  authentication  of  both  the  bonds 
and  coupons,  the  certification  by  a  trustee,  the  attaching 
of  the  official  seal  and  issuance,  mutilation  and  destruc- 
tion of  temporary  certificates  on  the  mortgage.     Provi- 
sions are  made  also  for  the  cancellation  of  coupons  and 
bonds  when  due  and  the  method  of  delivery  to  the  com- 
pany. 

12.  The  mortgagor  agrees  to  maintain  the  lien,  to 
pay  all  mechanics  and  labor  and  other  prior  claims  in 
order  to  maintain  the  mortgages'  priority,  taxes,  assess- 
ments, governmental  charges,  insurance,  etc.     Since  the 
adoption  of  the  new  Federal  Income  Tax  Law,  the  ten- 
dency, especially  in  the  large  mortgage,  is  to  require  per- 
sons entitled  to  interest  to  furnish  the  proper  certificates 
showing  compliance  with  the  law  in  order  to  protect  the 
company  against  any  liability  for  the  payment  of  these 
taxes.1 

13.  It  is  customary  to  include  an  agreement  to  keep 
the  mortgaged  property  in  good  condition  and  properly 
to  repair  and  replace  all  worn-out  equipment. 

14.  When  a  sinking  fund  provision  exists,  the  man- 
ner in  which  this  fund  shall  be  accumulated  and  the 
details  by  which  the  plan  shall  be  carried  out  are  given. 

15.  Where  the  mortgagor  is  to  have  the  option  of 
calling  the  bonds  upon  any  interest  date,  or  the  bonds  are 
to  be  retired  by  serial  payment,  the  manner  and  time  of 
notification,  of  payment,  etc.,  are  stated. 

16.  If  a  part  of  the  issue  is  to  be  used  in  refunding 
a  prior  issue,  the  plan  of  refunding  must  be  set  forth  in 
detail. 

17.  Some  bonds  or  mortgages  contain  the  option  to 
convert  into  the  capital  stock  of  the  issuing  company  or 


'The  former  practice  of  the  obligor  to  covenant  to  pay  the  principal 
and  interest  without  deduction  of  taxes  is  now  being  omitted  by  many 
corporations.  At  the  present  waiting  there  still  seems  to  be  a  dispute 
PS  to  -whether  the  promise  of  the  mortgagor  to  pay  the  Federal  Income 
Tax  is  not  void. 


116  INVESTMENT  ANALYSIS 

other  securities  agreed  upon;  in  such  cases,  the  method 
of  conversion,  the  time  limits  of  conversion,  the  price, 
etc.,  are  given.  The  same  detailed  provisions  should  be 
required  where  interchange  of  coupon  or  registered  bonds 
is  allowed,  and  provision  should  be  made  for  the  replac- 
ing of  lost  and  mutilated  securities. 

18.  Then  comes  the  recital  stipulating  in  the  agree- 
ment that  all  control  of  administration  and  operation  be 
given  into  the  hands  of  the  trustee. 

19.  Provisions   and   regulations   governing  defalca- 
tion, foreclosure,  the  duties,  rights,  liabilities  and  waivers 
of  trustees,  officers  and  stockholders  are  in  the  mortgage.1 

20.  The  mortgage  makes  provision  for  the  registra- 
tion of  the  principal,  and  some  mortgages  include  the 
interest  and  the  place,  time  and  method  of  payment,  sig- 
nature, etc. 

21.  "When  the  mortgage  has  been  approved  by  the 
legal  counsel  of  the  corporation  and  trustee,  and  such 
necessary  changes  made,  as  agreed  upon,  the  instrument 
is  signed  by  the  president  of  the  company  and  the  trustee, 
and  the  respective  seal  of  each  affixed  and  attested  by 
their  secretaries. 

22.  Provisions  are  usually  made  in  large  mortgages 
for  any  changes  that  may  be  made  in  the  instrument, 
when  all  parties  to  the  mortgage  approve. 

23.  Where  it  is  desirable  for  the  mortgagor  to  obtain 
releases   for  certain   parts  of   its  properties,   especially 
where  government  regulation  requires  it,  the  reservations 
protecting  all  interests  must  be  complete,  and  at  the  same 
time  give  considerable  latitude.2 

24.  A  covenant  should  be  made  in  the  mortgage  pro- 
viding, where  required,  for  the  keeping  of  the  transfer 
books  at  the  office  of  the  registrar,  as  also  for  the  trans- 
fer agency. 

25.  A  number  of  original  copies  are  usually  issued 
and  considered  as  one  instrument,  in  order  to  facilitate 
the  recording  of  the  mortgage  when  the  corporation,  as 
in  the  case  of  a  railroad,  has  properties  extending  into 
several  states.     In  all  states  it  must  at  least  be  filed  with 
the   Secretary  of   State,   and   in   some   states   with   the 
Eecorder  of  each  county  through  which  the  property  is 
domiciled. 


JThese  are  discussed  in  detail  under  a  subsequent  heading. 
'Example  of  Northern  Pacific  Mortgage  of  1914. 


CORPORATION  MORTGAGE  117 

26.  All  terms  which  need  an  explanation  should  be 
clearly  defined. 

27.  Lastly,  after  the  acceptance  by  the  trustee,  and 
attestation  acknowledgments  by  proper  company  officials 
as  stipulated  in    (21),   the  mortgage  is  registered  and 
recorded  with  either,  or  both,  state  or  county  officials  em- 
powered with  this  duty. 

Other  Creditors'  Claims.1 — As  long  as  interest  charges  and 
principal  are  met  when  due,  and  the  corporation  gives  strong 
evidence  of  a  wide  enough  margin  of  profits  above  all  expenses 
for  the  future,  the  bondholder  has  little  concern  in  priorities. 
But  all  careful  business  planning  requires  that  the  risks  be 
known  and  covered  where  possible.  The  difference  made  by 
these  risks  in  the  value  of  securities  is  what  determines  the  dif- 
ference between  investment  and  speculation,  and  the  investor 
assumes  or  eliminates  these  risks  according  to  the  safety  of  the 
security  which  he  purchases.  A  knowledge  of  these  risks 
requires  an  understanding  of  legal  priorities,  as  well  as  an  appre- 
ciation of  the  financial  status  of  the  corporation.  In  the  pur- 
chase of  the  security  the  investor  does  not  anticipate  bankruptcy 
and  foreclosure,  but  he  should  know  what  the  legal  risk  in 
priority  is,  should  contingencies  ever  arise.  Investors,  through 
ignorance  of  their  priority  claims,  have  often  made  needless 
sacrifice  by  throwing  their  holdings  into  the  market  where  they 
would  have  held  them  had  they  known  of  the  advantage  which 
their  securities  possessed. 

Upon  the  foreclosure  of  a  mortgage,  the  court  provides  for 
the  sale  of  the  property  covered  by  the  mortgage  and  deter- 
mines to  whom  the  proceeds  shall  be  distributed  after  all 
the  expenses  of  foreclosure  have  been  paid.  Following 
these  expenses  in  precedence,  are  those  claims  specifically 
stipulated  as  having  priority  by  state  statutes  and  those  spe- 
cially designated  by  the  court.  The  latter  may  be  those  debts 
which  have  been  assumed  under  the  court's  own  orders.  Stat- 


JThe  student  of  investments  will  find  that  a  careful  study  of  the 
classification  and  description  of  bonds  will  give  some  assistance  in 
determining  priorities.  As  so  "strongly  emphasized  under  classification, 
the  name  of  a  bond  must  not  be  taken  as  the  basis  of  its  lien,  but  a 
careful  study  will  soon  determine  what  can  be  accepted. 


118  INVESTMENT  ANALYSIS 

utes  almost  always  declare  that  taxes  and  all  forms  of  govern- 
ment assessments  shall  have  priority  over  all  creditors'  claims 
regardless  of  when  the  tax  was  levied. 

The  statutes  of  most  states  provide  for  the  priority  of  all 
operating  expenses  and  receiver's  certificates,  which  may  be 
taken  at  the  court's  determination  from  the  earnings  of  the 
property  during  receivership  or  from  the  sale  of  the  property 
itself.  It  is  also  a  well  established  principle  in  a  few  states, 
that  the  operating  expenses  incurred  six  months  before  receiver- 
ship may  be  given  the  same  preference.  When  preference  is 
given  by  statute  to  mechanics'  wages — i.e.,  the  wages  of  those 
performing  physical  labor  (and  also  in  some  states  of  those 
performing  service) — and  materials  for  construction  to  keep 
the  properties  intact,  these  rights  precede  those  of  the  mort- 
gages. Unless,  however,  the  time  within  which  these  latter 
claims  can  be  filed  and  submitted  to  the  proper  officials  is  com- 
plied with,  these  creditors  are  classed  with  the  unsecured  cred- 
itors. If  the  income  that  should  have  been  used  for  operating 
expenses  is  placed  into  the  fixed  property,  then  operating 
expense,  if  not  fully  satisfied  out  of  income,  will  have  first  claim 
on  the  proceeds  from  the  sale  of  the  property  to  the  extent  of 
the  amount  put  in  the  property.  All  unsecured  creditors 
are  paid  after  the  claims  of  the  secured  creditors  have  been 
satisfied,  with  the  general  exception  of  priorities  granted. 
Judgments,  claims  for  property  condemned  for  public  utility 
purposes,  or  claims  against  the  corporations  are  classed  with 
unsecured  claims,  unless  the  judgment  or  decree  has  been  entered 
before  the  mortgage  was  authorized  and  issued.  When  the 
creditors  have  equal  rights,  an  equal  distribution  of  the  prop- 
erty is  usually  ordered  by  the  courts  to  satisfy  these  claims. 

Receivers'  certificates,  which  are  issued  to  enable  the  prop- 
erty to  continue  operation  and  to  maintain  both  the  property 
and  the  business,  preserve  the  value  of  the  securities  on  the 
properties.  Under  the  conditions  under  which  these  funds  are 
advanced,  all  statutes  recognize  the  equity  in  the  priority  of 
receivers'  certificates  over  other  forms  of  secured  obligations. 

After  all  the  aforesaid  claims,  together  with  the  trustees  and 
receivership  expenses,  have  been  adjusted,  secured  creditors  or 


CORPORATION  MORTGAGE  119 

bondholders  are  entitled  to  be  paid.  There  is  a  well  established 
principle  governing  the  priority  of  mortgages  which  the  mort- 
gage that  has  been  recorded  first  secures,  i.  e.,  a  prior  claim 
to  payment  from  the  sale  of  the  property  on  which  it  is 
levied.  On  other  property  of  the  corporation  on  which  the 
mortgage  has  no  specified  claim,  it  is  on  an  equal  basis  with 
other  general  creditors.  If  prior  mortgage  liens  exist,  these 
must  be  paid  in  full  before  the  foreclosing  mortgage  may  receive 
anything,  but  only  to  the  extent  that  the  proceeds  from  the  sale 
of  the  property  will  satisfy  such  a  claim.  Prior  mortgage 
bondholders,  however,  may  partially  waive  their  claims  in  favor 
of  subsequent  mortgage  holders.  This  is  done,  especially  by 
security  holders  in  large  corporations,  to  facilitate  reorganiza- 
tion where  it  is  seen  that  money  can  be  raised  through  a  new 
issue  that  will  provide  the  necessary  funds  to  relieve  the  em- 
barrassment of  the  company,  otherwise,  the  parties  waiving 
their  rights  might  suffer  large  losses  by  forcing  a  sale  of  the 
property. 

All  bonds  of  the  same  issue  will  have  equal  claims  against 
the  property  upon  which  the  mortgage  is  issued,  unless  the 
bonds  have  been  classified  in  the  mortgage  and  given  priority 
according  to  their  series  or  numbers.  A  subsequent  mortgage 
issued  first,  must  be  a  subsequent  claim,  even  if  the  mortgage  on 
the  first  authorization  is  issued  after  the  subsequent  issue,  as 
long  as  the  first  mortgage  was  previously  recorded.  The  pur- 
chase-money-mortgage is  an  exception  to  this  general  statement, 
as  a  mortgage  lien  upon  property  purchased  from  the  sale  of 
this  bond  has  priority  over  all  issues,  as  applied  to  this  property 
purchased.1 

Where  a  clause  exists  in  the  regulation  of  preferred  stock, 
stating  that  this  stock  shall  have  prior  claim  to  any  future  bond 
issues  upon  the  property,  this  agreement  has  precedence  over 
subsequent  bond  issues.  In  all  other  cases  bonds  have  prior 
claim. 

All  debenture  bondholders  are  in  the  position  of  unsecured 


1See  chapter  xvii,  Equipment  Securities.  The  issue  of  equipment 
bonds  on  a  conditional  sale  is  also  a  first  claim,  though  we  have  a  differ- 
ence here  in  that  the  property  does  not  pass  into  possession  of  the  rail- 
road until  the  last  bond  has  been  retired. 


120  INVESTMENT  ANALYSIS 

creditors  and  cannot  receive  any  proceeds  from  the  sale  of  the 
property  until  all  secured  liens  have  been  paid  in  full.  But 
debenture  bondholders  do  have  precedence  over  all  stock- 
holders' claims.  Most  debenture  issues  now,  however,  provide 
that  the  debenture  issue  shall  have  prior  claim  over  any  future 
bonds  or  notes  issued.  A  debenture  issue  would,  then,  auto- 
matically really  become  a  specific  claim  upon  the  property 
though  no  changes  are  made  in  the  issue  outstanding. 

The  priority  of  all  secured  liens  must  be  individually  deter- 
mined. The  turn  in  which  they  are  officially  recorded  with  the 
proper  public  official,  is  the  most  common  determinant  of  priority 
in  relation  to  other  executed  mortgages.  "When  the  mortgage 
has  been  recorded  and  the  lien  thus  established,  it  cannot  be 
changed.  What  these  liens  are,  then,  must  be  ascertained  from 
the  mortgage  instruments — the  name  of  the  instrument,  as  we 
have  already  found,  is  never  a  safe  guide.  A  reliable  banker 
who  has  underwritten  an  issue  of  bonds  is  always  willing  to  give 
this  information  when  it  is  requested. 

Powers,  Rights,  and  Liabilities  jof  the  Trustee. — As  already 
noted,  it  is  essential  that  a  common  mortgage  be  issued  to 
secure  a  bond  issue.  "Without  this,  the  corporation  would  not 
be  able  to  split  its  bond  issue  into  fractional  parts  to  facilitate 
the  selling  of  the  obligation.  Unless  this  could  be  done,  it 
would  be  exceedingly  difficult  to  find  a  purchaser,  or  even  a 
small  group  of  combined  purchasers  who  would  be  willing,  even 
if  they  could,  to  place  all  of  their  investments  in  the  security. 
If  fractional  mortgages  were  issued  to  secure  each  small  denom- 
ination of  bonds,  there  would  be  an  added  difficulty  of  trans- 
ferring and  recording  the  mortgage  each  time  that  a  bond  was 
sold,  if  safety  to  the  holder  were  insured.  To  obviate  these  diffi- 
culties, the  one  mortgage  issued  and  recorded  and  securing  all 
of  the  fractional  denominations  of  the  issue  is  assigned  to  a 
trustee,  who  is  thereby  made  the  representative  of  the  bond- 
holder. It  is  his  duty  to  see  that  the  property  is  properly  con- 
served and  that  funds  are  not  diverted  which  properly  belong 
to  the  payment  of  principal  and  interest,  and  to  bring  legal 
action  when  necessary  to  protect  the  interests  of  the  bond- 
holders. Where  all  payments  are  being  properly  met,  there  is 


CORPORATION  MORTGAGE  121 

rarely  any  necessity  for  action.  It  is  usually  only  in  foreclos- 
ure that  the  trustee  needs  to  take  action. 

Trust  companies  are  now  practically  always  appointed  as 
trustees,  as  they  have  greater  facilities  than  an  individual  for 
supervising  the  interest  of  the  bondholders.  A  trust  company 
for  all  practical  purposes  is  perpetual,  a  fact  which  dispenses 
with  the  necessity  of  reappointments  because  of  death,  etc.  And 
lastly,  the  trust  company  carries  with  it  great  confidence. 

With  the  large  delegation  of  power,  there  must  follow  a 
large  degree  of  responsibility  on  the  part  of  the  trustee  to  bond- 
holders. The  accountability  of  the  trustees,  however,  applies 
only  to  any  lack  of  faithfulness  in  the  exercise  of  his  power. 
As  long  as  the  trustee  has  used  diligence  and  reasonable  care 
in  exercising  the  duties  of  his  trust,  the  law  relieves  him  from 
any  personal  responsibility,  and  this  is  accepted  by  the  bond- 
holders when  they  purchase  their  bonds.  If  the  bondholders, 
however,  have  assented  in  any  way  to  the  wrongful  acts  of  the 
trustee,  they  have  no  grounds  for  action,  as  they  are  parties  of 
the  act.  On  the  other  hand,  the  trustee  is  liable  to  a  third  party 
for  any  damages  in  operating  the  property.  But  the  mortgage 
deed  makes  provisions  for  reimbursement  to  the  trustee  for  such 
damages,  where  they  are  not  the  result  of  personal  neglect.  The 
trustee  is  required  to  take  personal  charge  where  executive  con- 
trol and  administration  are  required.  This  is  the  purpose  of 
having  a  trustee,  and  to  delegate  to  others  such  powers  would 
defeat  the  purposes  of  a  trusteeship.  It  does  not,  however,  limit 
his  power  to  delegate  the  functions  of  routine  in  an  executive 
office. 

Though  the  trustee  is  appointed  by  the  corporation,  he  is  a 
representative  of  the  bondholder.  "With  the  duties  of  the  trus- 
tee closely  denned  by  both  the  mortgage  and  state  statutes,  he 
now  has  little  power  outside  the  scope  of  these  defined  rights. 
Further,  all  acts  of  the  trustee  are  subject  to  review  by  the 
courts. 

The  chief  powers,  rights,  and  obligations  of  the  trustee  may 
be  summarized  as  follows : 

1.     To  certify  the  bonds  issued  upon  the  mortgage 
under  his  trusteeship ; 


122  INVESTMENT  ANALYSIS 

2.  To  see  that  interest  charges  and  principal  are 
paid  when  due; 

3.  To  keep  a  check  upon  the  physical  condition  of 
the  property; 

4.  To  see  that  the  funds  belonging  to  the  mortgage 
holders  are  not  dissipated; 

5.  To  seize  the  property  of  the  corporation  under 
authority  of  the  court  when  either  principal  or  interest 
is  not  paid,  provided  this  power  exists,  whether  by  stat- 
ute, or  provision  in  the  mortgage  where  such  is  allow- 
able by  law; 

6.  To  bring  foreclosure  proceedings  and  to  request 
the  court  to  appoint  a  receiver,  if  either  interest  or  prin- 
cipal is  not  paid; 

7.  To  sell  the  property  in  case  of  foreclosure,  with- 
out operating  it,  if  the  mortgage  expressly  so  provides. 

Special  conditions  affecting  the  trustee  are: 

1.  "Where  a  trustee  is  doubtful  as  to  the  method  of 
procedure,  he  should  appeal  to  the  court  for  guidance ; 

2.  He  may  seek  legal  counsel  and  not  be  liable  for 
accepting  this  advice  where  he  is  following  it  in  good 
faith ; 

3.  If  the  mortgage  deed  states  that  any  actions  of 
the  trustee  shall  be  governed  by  a  specified  vote  of  the 
bondholders,  both  the  trustee  and  all  bondholders  are 
governed  by  such  vote ; 

4.  The  trustee  may  be  removed  for  any  wilful  acts 
of  either  omission  or  commission  that  injure  the  rights  of 
the  bondholder ; 

5.  A  trustee  cannot  resign  without  the  consent  of 
both  the  bondholders  and  the  corporation,  except  where 
his  resignation  is  expressly  provided  for  in  the  mortgage ; 

6.  The  compensation  of  the  trustee  may  be  fixed  by 
common  agreement  or  by  the  mortgage;  all  reasonable 
expenses  in  carrying  out  duties  of  the  trusteeship  are 
always  allowed  by  law. 

The  bondholder  is  bound  by  any  acts  that  the  trustee  exer- 
cises, under  the  recitals  of  the  mortgage.  If  the  trustee's 
neglect  of  duty  has  decreased  the  value  of  the  property,  the 
bondholders  can  apply  to  the  court  for  an  order  for  the  removal 
of  the  trustee.  Practically  all  mortgages  of  large  corporations 


CORPORATION  MORTGAGE  123 

provide  that  the  written  statement  filed  by  a  given  number  of 
bondholders  will  remove  the  trustee  from  office.  Where  such 
provision  is  not  made  in  the  mortgage,  the  trustee  can  be 
removed  only  by  authority  of  the  court.  If  the  trustee  is 
removed  by  the  court,  one  or  more  of  the  bondholders  selected 
as  a  committee  by  the  majority  of  the  bondholders  will  assume 
charge  of  the  litigation  affecting  the  mortgage.  The  court 
also  has  the  right  to  command  the  trustee  to  perform  such 
duties  as  it  deems  are  the  functions  of  the  trustee  under 
the  mortgage. 

Rights,  Powers,  and  Limitations  in  Foreclosure. — When  the 
corporation  defaults  on  its  mortgage,  the  right  of  control  passes 
to  the  trustee.  The  default  may  consist  of  the  failure  to  pay 
any  part  or  all  of  the  principal,  or  the  interest,  when  due,  or 
the  failure  to  meet  certain  other  requirements  specified  in  the 
mortgage.  If  a  default  takes  place,  the  mortgage  instrument 
usually  stipulates  that  at  least  a  majority  vote  of  the  bond- 
holders is  necessary  before  the  trustee  can  declare  defalcation. 

Most  mortgages  require  the  consent  of  a  specified  number  of 
the  bondholders  before  the  trustee  can  institute  proceedings. 
As  provided  by  the  mortgage,  if  the  corporation  defaults,  the 
trustee  may  either  sell  the  property  without  taking  over  the 
management  or  he  may  take  the  corporation  over  and  operate 
it  and  sell  it  when  he  deems  it  prudent  to  do  so.  But,  even 
though  these  conditions  are  given  in  the  instrument,  they  do  not 
prevent  the  right  of  the  bondholders  to  ask  for  foreclosure  in 
the  courts.  This  is  a  right  given  by  law  which  supersedes  any 
right  conveyed  by  the  mortgage.  The  latter  action,  however, 
cannot  be  taken  until  a  given  time  after  the  default  or  after  the 
bondholders  have  given  their  consent. 

Practically  all  mortgages,  to  safeguard  against  hasty  action 
or  the  taking  of  undue  advantage  by  either  parties  to  the  mort- 
gage, defer  any  action  until  after  a  given  period  has  elapsed 
after  the  default  upon  the  mortgage.  In  either  case,  the  action 
must  be  approved  by  a  specified  percentage  of  the  bondholders, 
or  the  trustee  given  the  power  in  the  instrument.  When  the 
trustee  does  assume  control,  lie  maintains  it  until  all  claims  have 
been  adjusted.  The  state  statutes,  on  the  other  hand,  fix  the 


124  INVESTMENT  ANALYSIS 

time  limit  within  which  action  for  any  claims  against  the  mort- 
gage may  be  taken  by  its  statute  of  limitations. 

The  right  of  seizure  of  the  properties  for  any  default  of 
interest  may  be  waived  according  to  the  conditions  stated  in  the 
mortgage.  The  instrument  should  provide  that  any  such  action 
should  include  the  right  of  claims  for  the  principal,  as  well  as 
the  interest.  But  this  does  not  affect  any  subsequent  default 
or  does  it  affect  any  of  the  existing  rights  of  the  bondholders. 
This  waiver  may  be  given  even  after  the  proceedings  against 
the  corporation  have  started.  The  corporation  is  then  given 
back  complete  control  of  its  properties.  The  mortgage  further 
usually  provides  that  the  corporation  may  retain  possession  of 
its  properties  by  authority  of  the  court,  either  before  the  con- 
clusion of  foreclosure  proceedings,  or  before  the  consummation 
of  the  sale  of  the  properties,  if  all  charges  and  expenses  have 
been  met.  But  this  in  no  way  affects  the  future  rights  or  acts 
of  either  party.  Where  under  the  law  the  trustee's  right  to 
sell  may  be  included,  this  right  must  be  given  in  the  mortgage. 
If  given  the  power  to  sell  at  his  own  discretion,  the  trustee  may 
do  so  without  taking  over  the  control  of  the  property.  "When 
the  trustee  assumes  possession  of  the  properties  of  the  corpora- 
tion, the  mortgage  may  either  have  provisions  allowing  him  to 
lease  the  property,  or  take  immediate  control  of  operations. 
The  regulations  contained  in  the  mortgage  affecting  either  the 
lease  or  the  operation  of  the  property  are  widely  different.  In 
some  states  statutes  fix  the  important  limitations.  As  the  trus- 
tee does  not  represent  the  court  when  he  assumes  direct  opera- 
tion, he  becomes  personally  liable  except  where  exempted  by 
statute.  This  necessitates  a  provision  in  the  mortgage  or  vote 
of  the  bondholders,  which  will  reimburse  the  trustee  for  any 
liability  charges  that  may  arise  against  the  trustee.  All 
expenses  incurred  in  the  operation  of  the  property  are  met  by 
the  usual  methods  out  of  the  earnings  of  the  property. 

The  trustee  seldom  will  sell  or  operate  the  property,  but  will 
practically  always  apply  for  foreclosure  proceedings  in  the 
court.1  "Where  the  property  is  affected  by  the  statutes  of  sev- 


lrrhe  operating  of  the  properties,  which  formerly  was  frequently 
done,  is  now  made  impracticable  by  the  restrictions  placed  on  foreign 


CORPORATION  MORTGAGE  125 

eral  states,  as  with  railroads,  the  complexity  of  the  various 
statutes  regarding  the  different  priorities  makes  the  appeal  of 
the  trustee  to  the  court  for  a  foreclosure  and  receivership  the 
simplest  and  safest  procedure.  If  the  foreclosure  is  granted, 
the  court  appoints  a  receiver  who  assumes  control  of  the  prop- 
erty. In  foreclosure  the  rights  of  all  creditors  are  considered 
by  the  court,  and  the  latter  appoints  a  receiver  who  takes  charge 
of  the  property  for  the  court  and  may  operate  the  property  if 
directed  by  the  court.  The  limitations  of  the  trustee's  power 
to  foreclose,  as  previously  stated,  usually  require  that  a  specified 
number  of  bondholders  must  give  their  consent.  When  no 
regulations  are  given  in  the  mortgage  and  no  action  has  been 
taken,  after  the  "grace  days"  of  a  default  have  elapsed,  a 
minority  has  the  power  to  request  the  trustee  to  institute  fore- 
closure proceedings.  If  the  trustee  follows  such  a  recommenda- 
tion, the  majority  can  deter  the  action  of  the  trustee  only  by 
satisfying  the  claims  of  the  minority. 

When  the  trustee  is  negligent,  or  refuses  to  act  when 
officially  notified  by  the  bondholders,  the  court  can  authorize  the 
bondholders  to  institute  their  own  proceedings  of  foreclosure.1 

After  the  court  has  formulated  its  decree,  as  to  the  priorities 
and  the  amount  due  to  each  class  of  creditors,  the  corporation 
is  given  the  opportunity  of  making  a  payment  of  these  claims. 
The  time  allowed  and  the  conditions  governing  the  court's 
decree  vary  according  to  the  corporation's  state  domicile  and 
the  states  in  which  the  properties  are  located.  If  the  corpora- 
tion is  not  able  to  make  the  required  payments  according  to  the 
court's  decree,  the  property  is  offered  for  public  sale.  The 
court,  among  the  conditions  fixed,  states  a  minimum  price  at 
which  the  property  may  be  sold.  With  large  corporations,  in 
order  to  protect  all  interests,  the  bondholders  formulate  an 
agreement  and  appoint  a  committee  with  which  they  deposit 
their  bonds  for  the  purpose  of  purchasing  the  property  and  then 
organize  a  company  which  purchases  the  old  company.  In  a 


corporations,  and  the  liabilities  the  trust  may  assume  in  taking  over 
management  in  a  foreign  state.  The* exercise  of  this  right  should  always 
be  made  optional. 

'See  Priorities  and  Rights ;   The  Receiver  in  Operation  under  Other 
Creditors'  Claims. 


126  INVESTMENT  ANALYSIS 

few  states  the  organization  of  a  new  company  is  not  essential, 
as  a  corporation  is  automatically  created  by  the  purchase  of 
the  corporation  and  its  properties  at  foreclosure  sale. 

If  any  part  of  the  property  can  be  sold  without  causing 
harm  to  the  remaining  property  of  the  corporation,  this  part 
can  be  sold.  Usually  the  property  must  be  sold  as  an  entirety. 
The  decree  of  sale  of  the  mortgage  will  also  include  in  most 
cases  the  sale  of  the  franchise  or  charter.  Where  the  mortgage, 
as  is  often  the  situation  with  railroads,  is  on  a  particular  divi- 
sion, the  foreclosing  mortgage  has  no  rights  in  the  other  divi- 
sions of  the  railroad.  If  the  division  can  be  sold  without  injury 
to  the  remaining  property,  it  may  be  sold  as  a  separate  unit  by 
the  court's  decree.  Usually  this  is  not  done,  for  it  would  make 
the  security  of  the  division  a  very  much  less  desirable  holding. 

When  the  property  is  in  such  condition  that  it  will  deterior- 
ate during  foreclosure  proceedings  and  funds  are  not  available 
to  rehabilitate  it  and  keep  it  in  operation,  the  courts  have  in 
some  cases  ordered  that  the  property  be  sold  at  once.  As  this 
does  not  allow  for  a  representation  of  all  parties  and  a  settle- 
ment of  disputes,  the  courts  are  very  reluctant  to  take  such 
action  and  rarely  have  done  so. 

Where  the  interest  alone  has  been  defaulted  and  the  prop- 
erty is  largely  in  excess  of  the  indebtedness  as  determined  under 
the  foreclosure  proceedings,  but  this  amount  cannot  be  immedi- 
ately secured  from  the  operation  of  the  property,  it  may  be 
leased  to  avoid  the  losses  and  expenses  of  foreclosure.  If  the 
court  follows  this  procedure,  it  orders  the  trustee  to  lease  the 
property  at  a  fixed  rental  for  a  period  sufficient  to  meet  all 
claims,  with  the  agreement  that  the  property  will  be  kept  in 
good  condition.  It  is  only  when  the  property  has  a  very  large 
excess  value  that  this  procedure  is  followed. 

Settlements,  as  mentioned  under  "Other  Creditors'  Claims, " 
in  large  corporations  at  least  result  in  a  compromise.  Settle- 
ments are  usually  effected  by  an  agreement  reached  between  the 
various  committees  representing  the  different  bond  issues  and 
the  receiver  of  the  property.  In  large  corporations,  a  sale 
would  also  be  difficult  to  consummate  without  a  compromise  that 
would  include  an  exchange  of  old  securities  for  securities  in  the 
reorganized  corporation. 


CORPORATION  MORTGAGE  127 

If  an  investor  is  purchasing  new  securities  of  a  reorganized 
corporation  that  has  gone  through  receivership,  he  should  make 
certain  that  the  court's  orders  for  the  distribution  of  the  pro- 
ceeds of  the  receiver's  sale  have  been  sanctioned  and  the  final 
decree  signed  by  the  court.  While  no  securities  of  the  reorgan- 
ized corporation  can  be  officially  sold  until  this  decree  has  been 
signed,  it  is  well  to  take  this  precaution. 

If  the  directors  of  the  old  company  are  bidders  for  the  pur- 
chase of  the  property,  they  must  secure  the  court's  permission. 
As  long  as  any  party  can  show  evidence  of  ability  to  make  pay- 
ment, they  can  become  bidders  for  the  purchase  of  the  proper- 
ties. The  bondholders,  themselves  not  infrequently  combine  and 
purchase  the  property  in  order  to  conserve  their  interests.  It 
is  here  that  a  bondholder  must  especially  watch  that  he  does  not 
act  without  full  knowledge  of  what  the  committee  proposes  and 
has  legal  power  to  do.  Committees  are  sometimes  either  hastily 
formed  by  incompetent  men,  or  they,  while  still  acting  within 
their  legal  jurisdiction,  turn  their  organization  to  their  own 
interests  after  the  new  corporation  has  assumed  charge  of  the 
properties. 

When  the  bondholders  are  purchasers  of  the  foreclosed  cor- 
poration, they  are  practically  always  allowed  to  bid  in  their 
bonds  and  other  claims  if  sufficient  cash  has  been  advanced  to 
pay  the  costs  of  foreclosure  and  such  other  credit  claims  as 
must  be  paid  in  cash.  Any  sale  can  be  set  aside  by  the  court 
if  the  bondholders  can  show  legal  claims  against  the  sale.  This 
must,  however,  be  done  within  the  limit  set  by  the  court.  If 
the  claim  under  which  the  foreclosure  is  made,  is  on  a  real  estate 
mortgage  the  mortgagor  may  redeem  the  property  within  cer- 
tain statute  limitations,  even  after  the  foreclosure  sale.1 

Reorganization  Agreements  and  Procedure  in  Relation  to  the 
Mortgage. — When  a  foreclosure  seems  imminent  or  a  trustee  has 
actually  foreclosed  a  mortgage,  the  banking  house  which  under- 
wrote the  mortgage  or  those  investors  having  large  financial 
interests  in  the  corporation  appoint  a  committee.  This  commit- 
tee, which  is  usually  of  their  own  number,  formulates  an  agree- 
ment for  the  purchase  and  "exchange  of  the  securities  of  the  old 


'Real  Estate  Mortgages,  chapter  xxviii. 


128  INVESTMENT  ANALYSIS 

company,  and  the  formation  of  a  new  corporation.  The  com- 
mittee submits  its  purposed  agreement  to  the  bondholders  and 
other  interests  that  will  be  affected  by  the  foreclosure,  and 
these  may  determine  whether  the  proposed  plan  can  be  made 
operative.  With  the  plan  submitted  is  sent  a  request  asking 
the  bondholders  and  those  affected  to  deposit  their  securities 
with  a  trust  company  and  receive  in  return  a  certificate  of 
deposit. 

The  certificates  of  deposit  state  that  the  trustee  of  the 
deposited  securities  has  received  certain  securities  and  agrees  to 
bind  himself  to  the  terms  of  the  agreement.  These  certificates 
may  be  returned  to,  or  be  withdrawn  by,  the  owner  upon  his 
endorsing  the  deposit  certificates  to  the  trust  company.  A  time 
limit  is  usually  fixed  in  which  a  party  may  withdraw.  Such 
party  is  accountable  for  all  expenses  to  a  ratio  of  the  securities 
held  to  the  total ;  this  ratio  is  generally  fixed  at  not  higher  than 
one  per  cent  of  the  face  value  of  the  securities.  These  securi- 
ties can  be  transferred  like  any  certificate  upon  the  books  of  the 
company.  With  the  transference,  pass  the  terms  of  agreement 
of  the  original  owner.  A  time  limit  is  placed  upon  the  securi- 
ties which  can  be  deposited.  This  time-limit  can  be  changed 
only  at  the  will  of  the  committee  or  the  Court.  A  penalty  is 
usually  attached  to  any  tardiness. 

It  is  rare  that  a  bondholder  is  allowed  merely  to  sign  the 
agreement  without  depositing  his  securities.  Not  infrequently 
several  committees  will  be  appointed  and  a  vigorous  fight  will 
be  made  to  secure  a  sufficient  number  of  security  holders  to 
deposit  with  the  respective  committees  in  order  to  secure  control. 
It  is  needless  to  state  that  in  such  a  fight  considerable  discretion 
needs  to  be  exercised  in  the  selection  of  the  committee  with 
which  to  deposit  securities. 

As  practically  all  states  now  have  statutes  regulating  reor- 
ganization, many  of  the  details  of  the  agreement  that  can  be 
made  are  predetermined.  The  more  important  matters  in- 
cluded in  the  agreements  are: 

1.  The  appointment  of  the  committee  which   shall 
take  charge  of  reorganization  proceedings; 

2.  A  statement  of  the  rights  and  powers  of  this  com- 
mittee ; 


CORPORATION  MORTGAGE  129 

3.  A  specification  of  the  regulations  under  which  the 
securities  are  to  be  deposited  and  the  rights  and  obliga- 
tions of  the  depositors; 

4.  Arrangements  for  the  formulation  of  a  plan  of 
reorganization  and  the  incorporation  of  a  new  company, 
and  a  statement  of  what  the*  respective  rights  will  be  in 
the  new  corporation; 

5.  Provisions  for  all  special  powers  that  may  be  con- 
ferred  upon    the   committee   in   matters   which   can   be 
handled  more  expeditiously,  such  as  making  changes  in 
the  plans,  etc. ; 

6.  Provision  for  the  assessments  that  will  be  charged 
against  the  security  holders ; 

7.  Provision  for  the  expenses  of  reorganization  and 
the   salaries  of  the  committee  and  the  replacement  of 
members. 

If  the  reorganization  plan  is  contained  in  the  original  agree- 
ment, the  assent  to  the  plan  is  given  by  the  security  holder  in 
signing  the  agreement.  This  procedure  is  uncommon.  The 
ordinary  method  is  to  submit  the  plan  of  reorganization  for 
approval  at  a  later  date.  In  some  instances  the  agreement  gives 
complete  power  to  the  committee  to  formulate  and  carry  into 
execution  any  plan  it  may  agree  upon,  in  which  case  it  is 
unnecessary  for  it  to  submit  the  plan  to  the  security  holders 
for  approval,  though  the  latter  are  bound  by  an  equitable  and 
legal  plan  that  the  committee  may  adopt.  This,  of  course, 
assumes  that  the  stockholders  have  agreed  or  contracted  to  be 
bound  or  that  the  security  by  virtue  of  which  they  claim  their 
right  so  provides.  But  under  whatever  condition  the  plan  is 
submitted,  it  is  subject  to  the  court's  approval. 

When  the  plan  has  been  formulated,  it  is  filed  with  the 
depositary,  and  opportunity  is  given  all  security  holders  to 
examine  it.  Statutes  require  that  it  be  published  in  certain 
periodicals,  and  in  most  cases  a  copy  is  submitted  to  the  regis- 
tered holders  of  deposit  certificates.  If  the  plan  is  then 
accepted  by  the  security  holders,  the  committee  can  proceed  to 
make  its  bids  for  purchase  under  order  of  the  court.  If  the 
number  necessary  to  approve  is  not  stated  in  the  mortgage  or 
agreement,  the  will  of  any  majority  does  not  bind  the  minority, 
though  it  is  rare  that  this  point  is  not  covered  in  either  one  of 
these  instruments.  When  changes  are  made,  after  the  approval 


130  INVESTMENT  ANALYSIS 

of  the  reorganization,  they  must  again  be  submitted  to  the  secur- 
ity holders.  Minor  details  are  usually  left  to  the  committee  to 
pass  upon.  If  the  points  are  not  covered  in  the  agreement, 
recourse  may  be  had  to  the  court. 

The  powers  of  the  committee  in  carrying  out  the  plan  of  a 
reorganization  are  quite  broad.  They  are  often  given  the  power 
to  alter  a  plan  even  after  it  has  been  declared  in  operation. 
Stockholders  and  other  creditors  are  sometimes  allowed  by  the 
terms  of  the  agreement  to  join  in  the  reorganization  proceedings 
when  it  may  be  to  the  best  interests  of  all  parties.  The  terms 
and  the  conditions  are  usually  fixed  by  the  committee. 

A  security  holder  cannot  be  forced  to  participate  in  the  new 
corporation  except  that  he  may  have  already  pledged  himself  to 
become  a  member  of  such  proceedings  by  the  terms  of  the  mort- 
gage. He  has,  however,  a  right  to  share  in  the  sales  of  the 
property  which  secured  the  bonds.  The  same  is  true  if  the 
security  holder  has  withdrawn  from  the  agreement  or  the  reor- 
ganization is  given  up.  The  status  of  the  security  holder  in  the 
latter  case  is  the  same  as  if  no  proceedings  had  taken  place. 
If  the  mortgage  states  that  a  majority  shall  decide,  then  the 
minority  is  compelled  to  accept  their  decision.  The  court  has 
gone  to  the  extent,  where  such  a  rule  has  not  existed,  of  over- 
ruling the  minority  if  the  corporation  was  one  upon  which  the 
public  was  greatly  dependent,  as  in  the  case  of  a  public  utility. 

In  most  reorganizations  it  has  been  found  necessary  for  the 
bondholders  to  bring  other  creditors  and  even  stockholders  into 
the  reorganized  plan.  This  arrangement  avoids  the  objections 
that  may  be  raised  by  other  creditors  and  owners  of  the  corpora- 
tion. It  also  hastens  the  settlement,  which  usually  must  in  the 
end  be  carried  out  by  agreement.  The  stockholders  under  any 
condition  are  forced  to  bear  the  brunt  of  the  situation  and 
must  meet  the  heaviest  assessment  or  scaling  down  of  their 
holdings  in  the  new  company  or  both.  The  stockholders  have  no 
claims  upon  the  assets  until  the  claims  of  all  creditors  have 
been  satisfied,  and  it  is  only  by  consent  of  the  bondholders  that 
they  can  participate.  Very  frequently  the  large  stockholders 
are  large  holders  of  bonds,  and  to  retain  their  control  in  poli- 
cies, they  make  large  concessions  in  their  bond  holdings. 


CHAPTER  VIII 

REGISTRATION,    TRANSFER   AND    ASSIGNMENTS    OF 

SECURITIES,  AND  THEIR  VALIDITY  AND 

LEGALITY 

SECTION  I. 

An  understanding  of  the  more  important  requirements  con- 
cerning registration,  transfer,  and  assignment  of  stocks  and 
bonds  will  often  save  delays  as  well  as  losses  to  the  security 
holder.  An  understanding  of  the  principles  of  transfer  which 
are  often  considered  arbitrary  will  also  reveal  that  the  proced- 
ure has  been  built  up  with  the  particular  purpose  of  safeguard- 
ing the  security  holder.1  While  this  book  deals  with  bonds, 
the  simpler  approach  to  this  subject  is  suggested  in  the  trans- 
fer of  stocks.  Generally,  however,  the  conditions  governing  the 
transfer  of  stocks  are  common  to  the  transfer  of  registered 
bonds.  And  the  general  rules  as  to  the  signatures  and  similar 
matters  are  applicable  to  both  stocks  and  bonds. 

Transfer  of  Stock. — The  stock  certificate2  is  an  evidence  of 


*An  excellent  summary  of  the  legal  aspects  of  transfer  and  assign- 
ments for  the  layman  has  been  issued  by  the  Investment  Banker's 
Association  (1920)  under  the  authorship  of  H.  Brua  Campbell,  on  Legal 
Aspects  of  the  Transfer  of  Securities.  The  topic  under  Transfer  of 
Stock  has  largely  followed  the  order  of  this  little  book.  For  the  same 
purposes  F.  L.  Maraspin  and  H.  B.  Driver's  Fundamental  Principles  of 
Stock  Transfers  (1917)  will  be  found  useful;  for  th^  more  technical 
treatment  the  works  of  the  Corporation  Trust  Company,  Fletcher's, 
Private  Corporation,  and  Cook's  Corporations  are  standard. 

'Shares  $ each  Shares  $ each 

Number  Shares 

THE  X.  Y.  Z.  COMPANY 

Authorized  Capital  $ . 

INCORPORATED  UNDER  THE  LAWS  OF  THE  COMMONWEALTH 
OF  MASSACHUSETTS 

This  certifies  that   is  the  owner  of 

shares  of  the  capital  stock  of  the  X.  Y.  Z.  Company. 

transferable  only  on  the  books  of  the  Company  in  person  or  by  attorney 
upon  the  surrender  of  this  certificate  duly  endorsed. 

131 


132  INVESTMENT  ANALYSIS 

personal  ownership  in  the  share  or  shares  of  stocks  of  a  cor- 
poration. With  this  right  in  ownership  is  also  included  the 
right  to  pass  this  ownership  to  another  person.  But  for  the 
latter  person  to  have  a  legal  recognition  of  ownership,  the  fol- 
lowing requirements  exist:  (1)  the  stock  certificate  must  be 
assigned  by  the  transferrer  to  the  transferee;  (2)  the  transfer  is 
made  by  the  corporation  in  its  book,  and  a  record  of  the  new 
holder  made;  and  (3)  a  new  certificate  is  issued  to  the  new 
owner. 

The  assignment,  which,  as  some  one  has  expressed  it,  is  the 
key  to  the  whole  problem,  may  be  effected  in  two  different  ways 
as  described  in  the  Uniform  Stock  Transfer  Act:1  "Title  to  a 
certificate  and  to  the  shares  represented  thereby  shall  be  trans- 
ferred only,  (a)  by  the  delivery  of  the  certificate  endorsed 
either  in  blank  or  to  a  specified  person  by  the  person  appearing 
by  the  certificate  to  be  the  owner  of  the  shares  represented 


(Continued  from  footnote  on  page  131.) 

This  certificate  is  not  valid  until  countersigned  by  the  Transfer 
Agent  Registered  by  the  Registrar. 

In  witness  whereof  the  X.  Y.  Z.  Company  has  caused  this  certificate 
to  be  signed  by  its  duly  authorized  officers  and  its  corporate  seal  to  be 

affixed,  this day   of  

(Seal)    

Treasurer  President 

Countersigned  A.  B.  C.  Company, 

Transfer  Agent. 

By  

Registered  D.  E.  F.  Company, 

Registrar. 

By  

Agent  to  Register  Transfers. 

It  will  be  noticed  that  there  is  embodied  in  this  certificate:  (1)  the 
state  of  incorporation;  (2)  the  capitalization  of  the  company;  (3)  the 
par  value  of  the  shares  ;  (4)  the  class  of  stock  ;  (5)  the  certificate  num- 
ber; (6)  the  number  of  shares  owned;  (7)  the  name  of  stockholder; 
(8)  the  signature  of  the  officers  of  the  company;  (9)  the  corporate 
seal;  (10)  the  signature  of  the  transfer  agent;  (11)  the  signature  of 
the  registrar.  (F.  L.  Maraspin  and  H.  B.  Driver,  Fundamentals  of  Stock 
Transfers,  pp.  7,  8.) 

JThe  Uniform  Stock  Transfer  Act  quoted  above  has  been  adopted  in 
(1920)  thirteen  states  and  one  territory ;  namely,  Connecticut,  Illinois. 
Louisiana,  Maryland,  Massachusetts,  Michigan,  New  Oersey,  New  York, 
Ohio,  Pennsylvania,  Rhode  Island,  Tennessee,  Wisconsin,  and  Alaska. 
While  the  law  is  not  so  well  standardized  in  other  states,  a  cor- 
poration is  liable  if  they  refuse  to  transfer  stock  that  possesses  the  legal 
right  to  be  transferred.  A  corporation  wrongfully  refusing  to  transfer 
can  be  sued  for  damages.  A  corporation  is  also  required  to  exercise 
reasonable  diligence  in  the  recording  of  stockholders  in  its  transfers. 


TRANSFER  AND  ASSIGNMENT  133 

thereby,  or  (b)  by  delivery  of  the  certificate  and  a  separate 
document  containing  a  written  assignment1  of  the  certificate  or  a 
power  of  attorney  to  sell,  assign  or  transfer  the  same,  or  the 
shares  represented  thereby,  signed  by  the  person  appearing  by 
the  certificate  to  be  owner  of  the  shares  represented  thereby. 
Such  assignment  or  power  of  attorney  may  be  either  in  blank  or 
to  a  specified  person  .  .  .  ' 

The  latter  of  these  two  forms  of  transfers  is  generally  used, 
as  it  enables  the  recording  of  the  transfer  on  the  corporation's 
books  without  the  transferrer  being  present.  The  transferrer 
may  endorse  the  instrument  of  assignment  with  the  name  of  the 
transferee  inserted  or  left  blank.2  All  names  should  be  com- 
plete, and  no  initials,  prefixes,  or  titles  should  be  used.  Any 
qualification  of  ownership  should  be  fully  noted.  The  number 
of  shares  should  be  inserted  after  the  name  of  the  transferee. 
The  form  for  the  power  of  attorney  is  usually  left  blank  as  the 
transferrer  cannot  as  a  rule  appear  at  the  corporation's  office  to 
make  the  transfer.  The  company's  transfer  agent  can  then 
insert  his  own  name  and  make  the  transfer.  To  facilitate  the 
ready  delivery  from  hand  to  hand,  both  the  blanks  for  the  name 
of  the  transferee  and  attorney  are  left  blank.  Any  owner  may 
then  fill  in  the  blanks  of  the  assignment  and  insert  his  own 
name.  The  death  of  the  transferrer  will  not  impair  the  right  of 
the  holder  to  make  these  insertions.  If  the  name  of  the  attor- 
ney is  filled  in  before  the  certificate  is  presented  to  the  office  for 


'KNOW  ALL  MEN  BY  THESE  PRESENTS 

For  value  received hereby  sell,  assign,  and  transfer 

imto '. . .  shares  of  the  Capital  Stock  rep- 
resented by  the  within  Certificate,  and  do  hereby  irrevocably  constitute 

and  appoint Attorney  to  transfer 

the  said  stock  on  the  books  of  the  within-named  Company  with  full 
power  of  substitution  in  the  premises. 

Dated  this day  of 

Witness :  (Seal) 


F.  L.  Maraspin  and  H.  B.  Driver,  Fundamentals  of  Stock  Transfers 
(1917),  p.  10. 

2H.  Brua  Campbell,  Legal  Aspects  of  the  Transfer  of  Securities, 
p.  12.  (N.  Y.,  Doubleday,  Page  &  Co.,  for  Investment  Bankers'  Assoc. 
of  Amer.,  1920.)  (This  is  the  best  brief  summary  of  the  law  for  the  lay- 
man's use  that  has  yet  come  to  the  author's  attention,  and  for  this  rea- 
son this  book  has  been  frequently  referred  to  rather  than  to  a  treatise 
intended  for  the  lawyer.) 


134  INVESTMENT  ANALYSIS 

transfer,  it  should  be  accompanied  by  a  certificate  of  substitu- 
tion signed  by  the  attorney.  This  power  signed  in  blank  then 
is  completed  at  the  corporation's  office  in  the  same  way  as  a 
blank  power  of  assignment.  No  date  need  necessarily  appear 
on  the  assignment.  Care,  however,  should  be  taken  that  if  a 
name  is  entered  on  the  assignment  blank  that  this  name  should 
be  an  exact  duplication  of  the  name  on  the  face  of  the  certifi- 
cate. 

No  absolute  or  general  rule  can  be  laid  down  as  to  the 
requirements  of  signature.  Every  office  will  use  such  means,  as 
it  can,  to  satisfy  itself  as  to  the  genuineness  of  the  signature. 
In  some  cases  a  witness  of  a  known  person  to  the  transfer  office 
will  be  accepted  as  sufficient  evidence  of  identity  to  the  person 
signing.  In  New  York  the  common  practice  of  transfer  offices 
is  to  accept  the  signatures  of  a  firm  of  the  New  York  Stock 
Exchange  as  sufficient  guarantee  of  the  signature  of  the  trans- 
ferrer.  Where  the  latter  is  not  used  or  accepted,  a  notarial 
acknowledgement  of  the  signature  must  be  made. 

Summarized,  these  requirements  of  the  simplest  form  of  a 
transfer  from  Mr.  Arthur  Jones  to  Mr.  John  Smith  are:  (1) 
the  proper  endorsement  of  the  assignment  of  Mr.  Jones;  (2) 
either  an  acknowledgment  before  a  notary  public  of  the  sig- 
nature of  Mr.  Jones  or  guarantee  of  a  member  of  a  firm  of  the 
New  York  Stock  Exchange;  (3)  in  some  cases  a  witness  to  a 
signature  of  Mr.  Jones;  (4)  the  full  name  and  address  of  Mr. 
Smith;  (5)  the  payment  of  the  Federal  and  State  Transfer  tax 
which  is  shown  by  an  attached  transfer  stamp. 

Classification  of  Transfer.1 — The  commonly  accepted  classi- 
fication of  transfers  is:  (1)  by  an  individual;  (2)  by  the  ten- 
ants; (3)  by  partnerships;  (4)  by  corporations;  (5)  by  fidu- 
ciaries. The  transfer  of  the  individual  is  usually  simple.  The 
general  requirements  for  the  individual  transfer  are  those  stipu- 
lated under  the  preceding  topic. 

Concerning  the  transfer  between  husband  and  wife  the  state 
laws  are  somewhat  at  variance  and  the  statute  of  each  particu- 
lar state  should  be  consulted. 


*F.  L.  Maraspin  and  H.  B.  Driver,  Fundamental  Principles  of  Stock 
Transfers  (1917),  pp.  26-53. 


TRANSFER  AND  ASSIGNMENT  135 

"As  respects  such  transfers  it  would  seem  that  the  law  of 
the  domicile  of  the  married  woman  would  govern  the  respective 
rights  of  the  parties  to  the  transfer,  but  that  the  duty  of  the 
corporation  in  connection  with  the  transfer  would  be  deter- 
mined by  the  law  of  the  state  in  which  the  corporation  was 
organized/ 

"It  has  been  held  that  although  by  law  of  a  state  a  sale  of 
stock  by  a  married  woman  to  her  husband  without  an  order 
of  court  is  void,  nevertheless,  a  corporation  which  transfers 
stock  on  its  books  pursuant  to  such  sale  cannot  be  held  account- 
able to  her  thereof  unless,  at  the  time  it  made  the  transfer  or 
before  the  stock  got  into  the  hands  of  an  innocent  purchaser,  it 
had  notice  of  the  material  relation  existing  between  the 
parties. ' ' 

Where  one  does  not  have  the  legal  right  to  make  transfers, 
such  as  an  infant  or  one  otherwise  legally  disqualified,  a  repre- 
sentative must  be  legally  appointed  to  act  in  such  a  capacity. 
When  one  person  acts  in  place  of  another  or  acts  for  another 
by  virtue  of  an  appointment,  the  person  acting  for  this  person 
is  called  an  Attorney  in  Fact.  The  transfer  agent  must  have 
evidence  of  the  authenticity  of  the  attorney's  signature  and 
assure  himself  of  the  genuineness  of  the  power  of  attorney.  In 
case  of  bankruptcy  or  an  assignment  to  creditors,  all  power  of 
transfer  of  securities  is  thereby  surrendered  and  must  be  made 
by  the  properly  appointed  legal  representative. 

Where  two  or  more  persons  (other  than  husband  and  wife) 
hold  in  common  under  one  instrument,  a  joint  tenancy  is  said 
to  exist.  Where  two  or  more  persons  hold  property  in  com- 
mon but  under  separate  instruments,  indicating  the  interest  as 
separate,  the  arrangement  is  known  as  tenancy  in  common. 
Statutes  usually  provide  for  the  creation  of  tenancies  in  com- 
mon, and  in  that  case  a  transfer  of  stock  is  made  in  the  name 
of  each  individual  as  joint  tenant. 

In  a  partnership,  as  every  partner  is  an  agent,  a  transfer 
can  be  made  by  any  partner.  It  is,  however,  deemed  advisable 


'H.  Brua  Campbell,  Legal  Aspects  of  Transfer  of  Securities,  p.  21. 
(Reference  to  Cook  en  Corporations,  7th  Ed.,  pp.  62-954.) 

"Ibid.     (Reference  to  Fletcher  on  Private  Corporations,  p.  6436.) 


136  INVESTMENT  ANALYSIS 

where  the  partnership  owns  the  stock  and  a  partner  is  to  be- 
come the  possessor  of  the  stock,  that  some  other  member  of  the 
firm  make  the  assignment  for  the  firm. 

The  transfer  of  stock  owned  by  a  corporation  must  be  made 
by  an  official  designated  in  the  by-laws  of  the  corporation  with 
the  power  to  assign  and  transfer  securities.  A  copy  of  the  by- 
laws supporting  the  authority  of  the  corporation  officer's  power 
and  a  certificate  from  the  secretary  indicating  that  the  person 
signing  is  the  person  having  that  power,  are  required.  If  the 
power  of  transfer  is  not  specified,  the  board  of  directors  of 
the  corporation  may  convey  this  right  to  an  official  of  the  cor- 
poration. In  the  second  case  a  copy  of  the  minutes  conveying 
the  special  power  to  a  particular  officer  is  required.  The 
requirements  are  practically  the  same  where  any  form  of  asso- 
ciation, fraternal  or  other  form  of  voluntary  organization 
desires  to  transfer  stock.  Transfers  under  Fiduciaries,  i.  e., 
Executors,1  Guardians,2  Administrators,3  Conservators,4  and 
Trustees5  are  much  more  complicated  and  technical  than  the 
power  of  transfer  as  related  to  any  of  the  forms  of  transfer 
previously  discussed.  So  many  exacting  legal  differences  must 
be  observed  that  no  attempt  can  be  made  here  to  discuss  the 
details.  "What  may  apply  in  one  state  will  often  have  to  be 
modified  in  another  state.  So  many  changes  are  also  taking 
place  every  year  in  state  statutes  that  the  advice  of  a  trust 
company  should  always  be  sought  before  taking  action.  Be- 


1Executor — "One  to  whom  another  permits,  by  his  last  will,  the 
execution  of  that  will  and  testament." 

"Guardian — A  person  appointed  by  the  court  or  will  to  manage  the 
affairs  of  a  minor. 

"Administrator — An  Administrator  is  usually  an  individual  ap- 
pointed by  the  surrogate  or  probate  court  to  manage  and  distribute 
the  estate  of  a  testator  who  has  appointed  no  executor  in  his  will  or 
the  estate  of  a  person  dying  intestate. 

^Conservator — in  the  sense  in  which  this  term  is  used  above,  an 
individual  appointed  to  take  charge  of  the  affairs  of  an  individual 
advanced  in  age  or  of  one  whose  mental  weakness  incapacitates  him 
from  taking  care  of  his  estate. 

"Trustee — "A  person  in  whom  some  estate,  interest,  or  power  in 
or  affecting  property  of  any  description  is  vested  for  the  benefit  of  an- 
other, or  to  whom  the  property  has  been  conveyed  to  be  held  or  man- 
aged for  another."  (3  Bonv.  Law  Diet.  p.  3334.)  (Quoted  ) 


TRANSFER  AND  ASSIGNMENT  137 

cause  of  these  conditions,'  only  a  general  statement  is  made  for 
the  purpose  of  giving  the  general  reader  some  idea  of  the  prob- 
lems involved. 

In  any  form  of  control  and  administration  of  property,  the 
full  legal  evidence  of  the  powers  and  authority  of  the  offi- 
cial is  required  by  the  transfer  office  of  the  corporation.  In 
fact  the  general  principle  can  be  laid  down  that  no  action  can 
be  taken  in  the  administration  of  others'  affairs  without  legal 
evidence  of  authority.  When  stocks  in  the  name  of  a  dece- 
dent are  to  be  transferred,  a  certified  copy  of  the  will  and  a  cer- 
tificate showing  its  probate  and  testamentory  letters  as  to  the 
appointment  must  be  offered.  The  will  often  contains  specific 
direction  as  to  the  disposition  of  any  securities,  which  must  be 
complied  with.  In  some  states  an  executor  cannot  sell  prop- 
erty of  any  form  without  a  specific  order  from  the  court.  A 
certified  copy  of  this  order  from  the  court  must  then  also  be 
presented  at  the  transfer  office.  Particular  difficulties  in  this 
connection  are  apt  to  arise  as  to  whether  all  conditions  of  the 
order  have  been  met.  If  they  have  not  and  a  corporation 
has  transferred  stock  and  violated  some  requirement  of  the 
order  regulated  by  statute,  it  may  create  a  liability  against 
itself. 

Again,  the  power  of  an  executor  to  buy  and  sell  securities 
should  be  explicitly  stated.  If  the  power  is  a  general  one  to 
manage,  this  power  is  usually  implied.  In  some  states  this 
power  is  not  given  under  statute  except  by  a  specific  order  of 
the  Court.  To  avoid  danger  of  legal  complications  all  carefully 
drawn  instruments  provide  for  powers  to  sell  and  purchase 
securities.  The  same  conditions  also  apply  to  the  trustee.  As 
authorities  previously  referred  to  state :  "It  is  the  general  duty 
of  the  trustee  to  keep  the  property  which  is  left  him  in  trust  or 
conveyed  to  him  under  a  trust  instrument,  in  its  existing  form, 
that  is  to  collect  the  income  accruing  on  the  property  held  in 
trust  and  distribute  the  same  in  accordance  with  the  terms  of 
the  trust.  But  it  often  becomes  imperative  and  necessary  that 
certain  securities  be  sold  and  investments  changed,  and  the 
transfer  agent  would  be  bound  to  see  that  authority  for  such 


138  INVESTMENT  ANALYSIS 

action  was  given  the  trustee  by  the  terms  of  the  trust  instru- 
ment."1 

Also  a  fiduciary  has  not  the  legal  right  to  make  a  contract 
with  himself,  unless  specially  authorized  by  the  court ;  the  same 
applies  to  executors  of  an  estate.  To  further  safeguard  the 
trusteeship  against  transfers  of  this  character,  the  trustee  can- 
not give  general  powers  of  attorney  to  another  individual. 
Although  it  is  not  necessary  for  the  purchaser  from  a  trustee 
to  determine  whether  the  trustee  is  making  an  unauthorized 
sale,  or  for  the  corporation  to  ascertain  whether  a  misappro- 
priation of  funds  has  been  made,  yet  if  notice  has  been  given 
of  misappropriation  of  moneys,  the  purchaser  or  the  corpora- 
tion would  be  liable  for  such  a  transfer. 

In  a  number  of  states  the  transfers  of  securities  to  a  des- 
cendant must  also  be  accompanied  by  the  authority  of  a  state 
official  or  officials;  in  most  instances  this  requirement  is  made 
for  the  purpose  of  insuring  the  state  its  fees  or  taxes.  In  such 
cases  a  certified  copy  of  this  authority  should  also  be  required.2 

Illustrations  of  a  Transfer  Under  Fiduciaries'  Powers. — The 
general  requirements  governing  the  transfer  of  securities  of  a 
decedent  are  so  well  summarized  in  the  following  illustration  by 
E.  Brua  Campbell,  that  is  quoted  in  full: 

"As  illustrating  the  general  requirements  of  transfer  offices 
when  stock  belonging  to  the  estate  of  a  decedent  is  presented  for 
transfer  out  of  the  name  of  said  decedent,  let  us  assume  that 
John  Smith,  a  resident  of  Philadelphia,  is  the  registered  owner 
of  a  certificate  for  100  shares  of  the  common  stock  of  X  Railway 
Company,  a  corporation  organized  and  existing  under  the  laws 
of  the  State  of  Missouri.  The  said  John  Smith  dies  leaving  a 
last  will  and  testament  which  is  admitted  to  probate  in  the 


*F.  L.  Maraspin  and  H.  B.  Driver,  Fundamental  Principles  of  Stock 
Transfers  (1917),  p.  46. 

2  "In  no  case  will  a  transfer  from  an  executor  to  himself  individually 
be  recognized,  unless  it  appears  from  the  Will  that  he  is  a  residuary 
legatee,  and  unless  it  is  further  made  to  appear  by  affidavit  of  an 
executor,  that  all  legacies  and  all  claims  against  the  descendant  and 
his  estate  have  been  paid  in  full,  and  that  there  are  assets  sufficient  tc 
pay  the  remaining  expenses  of  administration.  In  no  case  will  a  trans- 
fer by  an  administrator  to  himself  be  recognized  unless  specifically 
authorized  by  the  court  controlling  its  administration."  (Spencer  Trask 
and  Company,  Unpublished  Memorandum.) 


TRANSFER  AND  ASSIGNMENT  139 

Orphans  Court  of  Philadelphia  County  and  letters  testamentary 
thereunder  are  issued  to  one  George  Brown.  The  executor  in 
order  to  pay  certain  debts  of  the  decedent  desires  to  sell  this 
stock  and  it  is  therefore  forwarded  to  a  brokerage  firm  in  New 
York  City,  where  the  Railway  Company  has  a  transfer  office  for 
the  convenience  of  its  security  holders,  with  the  request  that  it 
sell  the  same  for  and  on  account  of  the  estate.  The  firm  of 
brokers  effects  a  sale  of  the  stock  and  the  next  step  is  the  trans- 
fer of  the  certificate  into  the  name  of  the  purchaser  or  his  nom- 
inee on  the  books  of  the  Railway  Company.  The  usual  docu- 
ments and  proofs  which  the  Railway  Company  would  require 
before  making  this  transfer  are  the  following: 

(1)  An  officially  certified  copy  of  the  last  will  and 
testament  and  of  all  codicils  thereto,  of  the  decedent. 

(2)  An  officially  certified  copy  of  the  decree  or  a 
probate  certificate  of  recent  date  evidencing  the  appoint- 
ment and  qualification  of  executor  or  executors,  and  that 
such    appointment    remains   unrevoked.     In   New   York 
these  probate  certificates  are  sometimes  called  surrogate's 
certificates. 

(3)  Stock   certificate   properly   assigned   by    George 
Brown  ''as  Executor  of  the  Estate  of  John  Smith,  de- 
ceased," with   signature    guaranteed   by  a  firm  having 
membership   on   the  New   York   Stock   Exchange,   or  a 
notarial  acknowledgement  of  the  signature  in  lieu  of  said 
guarantee. 

(4)  Waiver  of  the  Comptroller  of  the  State  of  New 
York  consenting  to  the  transfer  under  the  Inheritance 
Tax  laws  of  said  state. 

(5)  Waiver  of  the  proper  authority  of  the  state  of 
Missouri  consenting  to  the  transfer  under  the  Inheritance 
Tax  laws  of  said  state. 

(6)  New  York  State  and  Federal  Transfer  Tax  stamps 
in  the  proper  amounts. 

It  is  believed  that  no  waiver  under  the  Inheritance  Tax  Laws 
of  Pennsylvania  would  be  required  in  this  case." 

Variations,  of  course,  in  the  detail  of  some  of  the  instru- 
ments of  authority  of  power  offered  to  the  transfer  office  by 
the  various  fiduciary  agents  must  be  taken  into  account  in  the 
above  quotation.  The  general  principle  of  application  in  the 
transfers  of  persons  acting  under  fiduciary  powers  is  well  illus- 
trated. 


JH.  Brua  Campbell,  Legal  Aspects  of  the  Transfer  of  Securities 
(1920) ,  pp.  30-31. 


140  INVESTMENT  ANALYSIS 

Lost,  Destroyed,  or  Stolen  Stock  Certificates. — Under  the 
Uniform  Stock  Transfer  Act,  the  law  provides  that:  "Where  a 
certificate  has  been  lost  or  destroyed,  a  court  of  competent  jur- 
isdiction may  order  the  issue  of  a  new  certificate."  This  is  the 
law  in  some  other  states  not  having  the  Uniform  Transfer  Act. 
The  evidence,  however,  must  be  sufficient  to  prove  such  loss. 
The  courts  have,  also,  generally  held  in  most  cases  that  a  bond 
of  indemnity  against  its  loss  to  any  bona  fide  holders  of  the 
lost  stock  certificates  must  be  furnished.1  In  addition  to  the 
indemnity  bond,  the  holder  is  usually  required  to  give  affidavit 
of  the  loss,  and  a  reasonable  amount  of  publicity. 

The  case  with  stolen  certificates  is  quite  different.  Stocks 
are  like  non-negotiable  bonds.  But  if  the  owner  allows  the  cer- 
tificate to  pass  from  his  hands  to  a  bona  fide  holder  endorsed  in 
blank,  the  question  of  negotiability  is  not  so  clearly  defined  and 
the  merits  of  the  case  must  be  established  upon  its  particular 
facts. 

The  Uniform  Transfer  Act  provides  that  if  the  certificate 
has  been  delivered  without  the  consent  of  the  owner,  he  may 
claim  the  certificate.  This  nullifies  the  transfer  except  in  case, 
"the  certificate  has  been  transferred  to  a  purchaser  for  value  in 
good  faith  without  notice  of  any  facts  making  the  transfer 
wrongful,  or  (2)  the  injured  person  has  elected  to  waive  the 
injury,  or  has  been  guilty  of  laches  in  endeavoring  to  enforce 
his  rights."2  A  considerable  clarification  has  been  brought 
about  by  the  Uniform  Transfer  Act  in  establishing  "the 
elements  of  negotiability  upon  a  stock  certificate  which, 
endorsed  in  blank  for  transfer  passes  into  bona  fide  hands  and 
such  would  seem  to  be  the  construction  placed  upon  it  by  the 
highest  courts  of  at  least  one  state."8 

Transfer  Taxes. — Transfer  taxes  discussed  in  the  chapter  on 
"Taxation  of  Securities"  are  becoming  of  increasing  import- 
ance. The  number  of  states  using  the  tax  on  stock  transfers  is 


1Fletcher,  Private  Corporations,  p.  5796. 
»Uniform  Transfer  Act,  sec.  168    (I). 

3Miller  v.  Doran,  151  111.  App.  527,  affd.  245  111.  200.     (Quoted  from 
H.  Brua  Campbell,  p.  68.) 


TRANSFER  AND  ASSIGNMENT  141 

still  very  limited,  but  will  be  increased.  With  this  transfer  tax 
should  also  be  added  the  Federal  stock  transfer  tax.  These,  of 
course,  do  not  apply  to  bond  transfers.  But  of  even  more 
importance  to  the  investor  are  the  Federal  and  state  inheri- 
tance and  estate  taxes  also  discussed  in  the  subsequent  chapter 
referred  to  above.  So  large  and  important  have  these  taxes 
become  that  the  question  as  to  what  form  an  estate  shall  be 
put  in  is  assuming  large  proportions. 

Negotiable  Instruments. — The  distinguishing  characteristics 
between  bonds  and  stocks  have  already  been  described  in  Chap- 
ter II.  For  purposes  of  transfer,  bonds  may  be  divided  into  the 
two  classes  of  negotiable  and  non-negotiable  instruments. 
Negotiability,  as  referred  to  here,  means  the  power  or  right 
possessed  by  an  instrument  to  be  transferred  from  person  to 
person  the  same  as  any  medium  of  exchange.  Coupon  bonds 
made  payable  to  bearer  fill  these  requirements  of  negotiability 
and  can  be  transferred  by  mere  delivery.  This  assumes  that 
the  holder  of  the  bond  has  no  notice  of  any  defenses  which  the 
former  holder  of  the  title  could  use  in  laying  claim  to  owner- 
ship of  the  instrument.  Again,  however,  any  variation  from 
the  requirements  stated  in  the  paragraph  following  may  alter 
the  negotiability  of  the  instrument.  This  must  be  decided  by 
the  facts  in  each  particular  case. 

The  conditions  and  rules  governing  registered  bonds  (the 
non-negotiable  instruments)  are  usually  set  forth  in  the  cor- 
poration mortgage  securing  the  bond  issue.  The  details  in  the 
mortgage  are  frequently  very  complete  and  should  be  examined 
with  extreme  care  if  a  mooted  question  on  the  transfer  ever 
arises. 

The  Uniform  Negotiable  Instruments  Law  which  is  now  used 
in  practically  all  states  is  applicable  to  corporate  bonds.  As 
provided  by  this  statute  the  more  important  requirements  essen- 
tial to  the  establishment  of  the  negotiability  of  a  corporate 
bond  are  as  follows:  "  (1)  It  must  be  in  writing  and  signed  by 
the  maker  or  the  drawer;  (2)  It  must  contain  an  unconditional 
promise  or  order  to  pay  a  certain  sum  in  money;  (3)  It  must  be 
payable  on  demand  or  at  a  fixed  or  determinable  future  time; 


142  INVESTMENT  ANALYSIS 

(4)  It  must  be  payable  to  order  or  bearer;  and  (5)  where  the 
instrument  is  addressed  to  a  drawee,  he  must  be  named  or 
otherwise  indicated  therein  with  reasonable  certainty."1 

Registered  Bonds.2 — A  registered  bond  is  one  which  is  pay- 
able to  a  designated  individual  and  is  registered  in  the  name  of 
this  individual  at  the  office  of  the  company  or  of  the  fiscal  agent 
of  the  company.  This  bond  has  no  coupons,  the  interest  being 
paid  by  checks  which  are  sent  to  the  registered  owner.  A  reg- 
istered bond,  consequently  cannot  be  transferred  until  the  payee 
has  assigned  it  or  an  assignment  is  executed  by  one  having  the 
power  of  attorney.  A  new  bond  will  then  be  made  out  for  the 
new  owner  by  the  corporation  or  civil  division.  By  conforming 
to  this  formality  of  transfer,  the  principal  and  interest  becomes 
due  to  the  last  name  which  appears  on  the  registry,  as  owner 
of  the  bond.  The  form  of  assignment  used  as  in  transferring 
of  stock  is  practically  always  printed  upon  the  back  of  the  bond. 

The  purpose  of  registration  is  to  insure  the  safety  of  the 
bond  against  theft  or  loss,  for  a  registered  bond  can  be  collected 
only  by  the  registered  payee.  The  inconvenience  and  delay  in 
the  sale  of  registered  bonds  have  led  to  a  very  limited  use  of 
this  privilege.  The  fact,  however,  that  so  many  bonds  contain 
the  privilege  of  inter-changeability  from  a  coupon  to  a  registered 
bond  is  evidence  in  itself  that  there  are  a  very  considerable 
number  of  registered  bonds  sold  or  coupon  bonds  are  later 
exchanged  for  registered  bonds. 

Coupon  Bonds. — A  coupon  bond  is  made  of  two  parts:  the 
instrument  representing  the  principal  sum  payable  to  a  named 
person  or  order  or  to  bearer,  and  the  series  of  interest  certifi- 
cates which  represent  the  respective  interest  payments  due  at 
stated  intervals.  These  interest  coupons,  which  are  attached  to 
the  part  of  the  bond  representing  the  principal  sum,  are  entirely 
independent  of  the  latter,  and  each  one  of  the  series  is  detached, 
as  it  comes  due,  and  is  presented  for  payment.  These  coupons, 
the  details  of  which  will  be  explained  later,  are  payable  to 


Joseph  Doddridge  Brannan,  The  Negotiable  Instruments  Law  An- 
notated (1920),  p.  2. 

The  details  governing  the  United  States  Bonds  and  Notes  which 
are  similar  to  the  principles  laid  down  in  this  chapter  can  be  found  in 
Circular  No.  141  of  The  Treasury  Department  of  the  United  States. 


TRANSFER  AND  ASSIGNMENT  143 

bearer  or  to  order,  and  when  detached  are  negotiable.  When 
the  coupons  are  separated  from  the  main  instrument  before  ma- 
turity, they  can  be  negotiated  like  a  promissory  note. 

The  most  common  form  of  issuing  the  coupon  is  to  the 
bearer.  If  a  negotiable  bond  is  made  payable  to  a  payee  or 
order  it  can  be  transferred  by  endorsement.  But  if  the  bond  is 
made  payable  to  a  payee  or  bearer,  all  that  is  necessary  to  make 
a  transfer  is  to  make  a  delivery  of  the  instrument. 

A  bond  may  be  registered,  either  as  to  principal  alone  or 
both  the  principal  and  interest.  When  the  principal  alone  is 
registered,  the  interest  coupons  are  negotiable  and  are  payable 
to  any  holder  on  their  due  date,  but  the  principal  can  be  paid 
only  to  the  registered  owner.  The  registration  is  made  by  the 
proper  official  writing  the  name  of  the  owner  in  a  space  pro- 
vided for  the  purpose,  and  recording  this  ownership  on  the 
books  of  the  company.  Where  the  indenture  provides  that  cou- 
pon bonds  may  later  be  registered  as  to  principal,  the  coupon 
bonds  have  a  form  provided  on  the  back  of  the  bond  where  the 
name  of  the  owner  may  be  inserted  by  the  trustee  or  agents 
for  the  company  as  being  entitled  to  the  principal  when  due. 

When  both  the  principal  and  interest  are  registered,  the 
coupon  is  usually  returned  to  the  corporation  and  a  registered 
bond  issued  to  the  owner  of  the  bond.  The  registration  is 
recorded  in  the  manner  described  in  the  preceding  paragraph. 
A  coupon  bond  can  be  made  a  fully  registered  bond  by  sending 
it  to  the  company  and  having  the  company  or  its  agents  detach 
the  coupons  and  fill  in  the  owner 's  name  on  the  space  ordinarily 
provided  to  register  the  bond  as  to  principal.  The  owner  then 
has  in  his  possession  the  indenture  of  a  bond  with  his  name 
written  on  the  back  by  the  company,  and  the  company  is  in 
possession  of  the  coupons.  When  the  interest  comes  due  the 
owner,  as  in  an  original  registered  bond,  the  company  sends  a 
check  direct  for  the  interest  payments. 

The  practice  with  most  companies,  where  a  fully  registered 
bond  is  to  be  converted,  is  to  issue  a  new  bond  with  coupons 
attached,  except  that  the  coupons  already  due  are  detached.  In 
cases  where  a  bond  has  been- fully  registered  by  detaching  the 
coupons  and  the  owner  desires  to  change  back  to  the  original 


144  INVESTMENT  ANALYSIS 

form,  the  bond  is  released  to  bearer  after  the  owner  has  signed 
a  power  of  attorney.  Sheets  of  coupons  bearing  the  same  num- 
ber as  the  indenture  are  again  attached.  Such  a  procedure, 
however,  is  unusual. 

Transfer  and  Assignment  of  Bonds. — Bonds  may  be  made 
payable  in  one  of  two  ways,  either  to  a  stated  payee  or  to  the 
bearer.  In  the  former  the  transfer  must  be  in  writing,  but  in 
the  latter,  the  bond  may  be  transferred  without  any  written 
form  of  agreement.  It  is  then  in  common  practice  called  a 
negotiable  instrument.  The  space  for  the  name  of  the  payee  is 
then  left  blank  and  the  bond  is  payable  to  the  bearer,  and  can 
be  delivered  to  any  one  without  any  other  formality  than  affects 
the  ordinary  sale  of  goods  across  a  merchandise  counter. 

Generally  bonds  are  transferred  by  a  bond  power  of  attor- 
ney, which  is  in  the  form  of  an  assignment,  the  holder's  name 
being  attested  to  by  a  witness.1  The  only  place  where  the 
holder  of  the  bond  is  entitled  to  write  upon  it  is  where  the  bond 
is  a  fully  registered  form  and  has  an  assignment  form  printed 
on  the  back.  The  proper  filling  in  of  this  assignment  form  is 
necessary  to  make  a  good  delivery.  It  cannot  be  too  strongly 
emphasized  that  the  owners  themselves  should  not  mark  or  in 
any  way  make  a  mark  that  indicates  ownership.  When  a  mark 
is  made  upon  a  bond  that  can  in  any  way  be  construed  as  mean- 
ing ownership,  the  New  York  Stock  Exchange  has  ruled  that 
this  bond  is  a  marked  bond  and  not  a  good  delivery  unless  sold 
as  a  marked  bond. 

When  a  bond  has  been  lost  or  destroyed,  the  owner  may 
compel  the  corporation  to  issue  a  new  bond  if  proof  can  be 
shown  of  the  loss  or  destruction  of  the  bond.*  With  stolen 
bonds  the  case  is  different.  If  a  negotiable  bond  is  stolen  and 
later  purchased  by  a  bona  fide  purchaser,  the  owner  from  whom 
the  bonds  were  stolen  has  no  claims  against  the  corporation  or 
municipality.  As  long  as  the  holder  of  a  bond  is  a  bona  fide 
one,  the  title  is  vested  in  his  name.  Where  the  bond  has  been 


'One  Stock  Exchange  firm  will  accept  such  a  power  from  another 
Stock  Exchange  house  attached  to  a  bond,  if  the  signature  is  guaran- 
teed, otherwise  it  must  be  acknowledged  before  a  Notary  Public. 

'Chesapeake  &  Ohio  Canal  Company  v.  Blair,  45  Md.  102. 


145 

stolen  after  the  maturity  date,  the  title  is  still  vested  in  the 
true  owner  and  not  the  bona  fide  holder. 

When  bonds  are  not  negotiable,  the  purchaser  of  the  stolen 
bonds  cannot  secure  a  vested  title  in  the  bonds.  Consequently, 
if  new  bonds  have  been  issued  for  the  stolen  bonds,  the  true 
owner  may  again  secure  possession  of  them  through  his  vested 
title  which  has  not  been  changed. 

Coupons. — A  coupon  severed  from  the  bond  is  a  separate 
and  negotiable  security.  It  is  a  separate  contract  and  is  not  a 
part  of  the  bond.  Each  coupon  constitutes  an  obligation  of 
the  company  which  has  promised  this  definite  sum  upon  a  cer- 
tain date.  A  coupon  has  no  right  to  interest  until  its  due  date, 
and  each  coupon  is  valued  at  the  discount  of  its  face  value  to 
the  date  of  its  respective  maturity.  When  detached,  it  can  be 
considered  as  an  independent  security  or  obligation  of  the  com- 
pany. Suit  can  be  brought  for  each  of  these  detached  instru- 
ments only  as  they  come  due,  and  the  individual  holder  cannot 
take  any  of  the  property  under  the  mortgage  apart  from  the 
other  holders. 

If  the  coupon  is  not  independently  negotiable,  separate 
action  for  its  recovery  cannot  be  brought.  Action  can  be 
brought  only  with  the  bond,  for  the  coupon  is  not  then  a  sep- 
arate instrument,  but  a  part  of  the  bond.  The  statutes  of  some 
states,  hold,  however,  that  if  the  bond  is  negotiable,  the  coupons 
are  negotiable,  as  a  part  of  the  instrument,  and  the  court  deci- 
sions of  other  states  have  supported  the  same  claim.  In  dis- 
puted cases,  it  is  an  accepted  rule  that  the  rules  governing  the 
principal  would  have  precedence  over  the  coupons. 

The  security  of  the  interest  coupons  is  the  same  as  that  of 
the  principal  of  the  bond.  Any  accrual  of  interest  is  entitled 
to  its  proportional  share  in  the  property.  Any  loss  due  to 
foreclosure  is  borne  proportionally  between  the  bonds  and  the 
coupons.  Normally,  in  foreclosure,  coupons  are  paid  in  the 
order  in  which  they  come  due,  all  coupons  and  the  principal  of 
the  bond  having  equal  priority.  Where  provisions  in  the  mort- 
gage give  priorities,  these  priorities,  especially  where  a  mort- 
gage secures  several  varieties  of  bonds,  have  been  fully  recog- 
nized by  the  courts. 


146  INVESTMENT  ANALYSIS 

When  a  coupon  becomes  due,  the  owner  clips  it  from  his 
bond  and  presents  it  for  payment  to  the  trustee  or  at  the  office 
of  the  corporation  agent  designated  in  the  mortgage.  If  the 
corporation  has  not  provided  a  place  for  the  redemption  of 
coupons,  they  must  be  presented  or  sent  to  the  corporation's 
own  office.  The  common  practice,  where  they  must  be  for- 
warded, is  to  deposit  them  with  a  bank,  which  can  more  easily 
and  safely  attend  to  their  collection.  Formerly,  as  long  as  the 
coupon  was  negotiable,  any  one  who  presented  it  had  the 
right  to  collect  it,  and  no  evidence  of  ownership  of  the  bond 
need  be  shown.  The  Federal  Tax  laws  have  practically  changed 
this,  in  that  an  ownership  certificate  describing  the  bonds  must 
be  presented  with  all  coupons  other  than  municipal  and  govern- 
ment bonds,  on  which  no  normal  income  tax  is  to  be  collected. 
This  makes  it  much  more  difficult  for  coupons  not  in  the  hands 
of  rightful  owners  to  be  cashed.  While  it  is  an  indication  of 
lack  of  foresightedness  to  do  so,  the  holder  can  present  his  cou- 
pon at  any  time  after  it  is  due  and  demand  payment,  though 
he  has  no  claim  for  interest  upon  the  amount  of  interest  due. 
Upon  payment,  the  coupons  are  cancelled. 

The  practices  of  the  states  differ  in  dealing  with  the  interest 
on  coupons  due  and  not  paid  by  the  corporation.  In  a  number 
of  states,  coupons  which  are  detached  and  negotiable  and  in 
possession  of  a  holder  other  than  the  holder  of  the  principal 
have  a  legal  claim  to  interest  when  the  coupon  is  overdue  and 
not  paid.  The  decisions  of  the  courts  have  also  varied 
where  the  coupons  are  in  the  hands  of  the  holder  of  the  bond, 
attached  or  detached.  The  weight  of  authority,  however,  has 
ruled  against  the  allowance  of  interest  on  covpons  in  the  hands 
of  the  holder  of  the  bond.  Where  the  rate  allowed  is  not  fixed 
by  the  mortgage,  it  is  usually  fixed  by  the  court  under  the 
restrictions  of  the  state  statutes. 

If  the  bond  can  be  called  before  the  due  date  given  on  the 
coupon,  the  recital  on  the  coupon  should  provide  for  its  pay- 
ment at  the  time  of  the  redemption  of  the  bond.  As  the  cou- 
pon is  a  separate  negotiable  obligation,1  it  is  essential  that  all 
qualifications  or  limitations  should  appear  upon  its  face. 


'Continental  Securities  Co.  v.  N.  Y.  Central  R.  R..  217  N.  Y.  119; 
1916. 


TRANSFER  AND  ASSIGNMENT  147 

SECTION  II. 
VALIDITY  AND  LEGALITY 

Problems  of  validity  and  legality  of  bonds  are  largely  con- 
fined to  the  issue  of  minor  civil  divisions.  Questions  involving 
validity  and  legality  of  issue  seldom  arise  in  connection  with 
private  corporations.  In  private  corporations,  the  holder  of 
the  bond  is  secured  by  actual  property  and  the  legality  of  the 
mortgage  securing  the  bond  is  attested  as  to  its  validity  by  the 
attorney.  The  corporate  mortgage  is  rarely  ever  subjected  to 
ignorant  and  inexperienced  attorneys  as  to  the  legality  of  issue. 
A  corporation  needs  no  coaching  to  be  made  aware  of  the  cost- 
liness of  such  procedure,  and  the  financial  loss  caused  by  the 
lack  of  strict  conformity  to  the  legal  requirements  of  the  mort- 
gage needs  no  argument.  This,  coupled  with  the  claim  upon  a 
specified  property  in  all  corporate  bond  issues,  has  also  very 
much  simplified  the  difficulties  involved  in  the  legality  of  cor- 
porate issues. 

In  the  civil  divisions,  where  only  the  bond  instrument  is 
issued,1  this  problem  in  the  past  has  always  been  a  large  and 
all-important  one.  The  not  infrequent  ambiguity  of  statutes,  as 
well  as  the  great  variation  of  statutes,  the  differences  in  judicial 
decisions,  and  the  large  number  of  local  officials  often  inexperi- 
enced who  must  pass  upon  these,  have  been  accountable  for  a 
large  number  of  the  difficulties  that  have  arisen  in  the  past  over 
the  validity  and  legality  of  the  minor  civil  division  issues.  The 
increasingly  more  rigid  interpretation,  and  the  holding  to  strict 
accountability  of  the  civil  divisions  that  have  received  the  bene- 
fits of  the  issue,  have  had  a  lasting  influence  upon  careless  offi- 
cials. But  a  very  much  larger  influence  in  eliminating  these 
objections  has  been  effected  by  the  care  of  the  investment 
bankers  in  underwriting  municipal  issues.  Any  issue  since 
1900  that  can  lay  claim  to  invalidity,  or  illegality  is  indeed  rare. 
The  claims  to  invalidity  have  practically  all  been  raised  con- 
cerning issues  brought  out  Ijefore  1900.  Further,  through  the 
efforts  of  the  bankers  and  the  interpretation  of  the  courts,  many 


'See  chapter  xxxiv  for  the  rare  exceptions  to  this  statement. 


148  INVESTMENT  ANALYSIS 

corrections  in  recent  years  have  been  made  in  municipal  bond 
law,  and  considerable  standardization  has  been  effected  in  the 
judicial  decisions  of  the  several  states.  Such  a  mistake  in  vio- 
lation of  statute,  as  a  municipality  voting  one  day  too  soon, 
after  a  former  rejection  of  the  same  issue  by  the  voters,  as 
occurred  in  one  municipality,  has  little  chance  of  escaping  the 
scrutiny  of  the  experienced  banking  firm.  Municipal  issues 
rejected  by  investment  bankers,  for  varying  degrees  of  errors 
in  conforming  to  legal  requirements,  amount  to  millions  of  dol- 
lars. But  this  does  not  eliminate  the  necessity  of  continued 
attention  to  this  problem. 

As  the  validity  and  legality  of  municipal  issues  are  discussed 
more  in  particular  under  Civil  Loans,  only  a  general  statement 
of  these  subjects  is  given  here.  It  would,  however,  be  impractical 
and  hardly  necessary  in  this  treatise  to  consider  other  than  the 
more  important  and  more  common  causes  of  illegality.  These 
causes  group  themselves  about  the  more  important  headings, 
considered  later  in  discussion  of  the  legal  requirements  of 
municipal  issues.  They  are:  (1)  the  purpose  for  which  munic- 
ipal bonds  may  be  lawfully  issued;  (2)  the  authority  or  power 
to  issue  municipal  bonds;  (3)  the  procedure  and  acts  of  the 
civil  authorities;  (4)  the  ratification  of  the  issue;  (5)  the  exe- 
cution, delivery,  form,  and  registration;  and  (6)  the  violations 
of  tax  and  bond  limitations  and  restrictions. 

Continued  simplification  in  the  regulation  and  method  of 
issues  is  decreasing  the  larger  part  of  the  difficulties  involved 
in  these  problems.  Reform  in  municipal  legislation,  however, 
has  never  gone  forward  with  great  alacrity,  Even  with  the 
increasing  tendency  of  the  courts  to  declare  an  invalid  issue 
legal  and  to  hold  liable  a  municipality  which  has  appropriated 
the  funds  of  an  issue,  an  appeal  to  the  courts  is  not  only  a 
doubtful  procedure  but  a  costly  one,  and  validation  from  this 
source  must  be  accepted  as  a  last  resource  for  a  bond  already 
in  hand. 

Courts  have  constantly  held  in  recent  years  that  the  recital 
on  the  face  of  the  bond  is  a  sufficient  cause  for  estoppel,  that  is, 
to  bar  the  municipality  from  repudiating  the  obligation.  This 
has  facilitated  the  standardization  of  bond  forms.  It  must  be 


TRANSFER  AND  ASSIGNMENT  149 

observed,  however,  that  these  recitals  serve  as  an  estoppel  only 
where  they  are  executed  by  those  authorized  by  law  to  issue 
them.  Further,  the  security  representing  to  have  a  legitimate 
claim  against  the  municipality  must  be  in  the  hands  of  a  bona 
fide  holder.  The  decisions  affecting  these  recitals  have  not  had 
reference  especially  to  the  recitals  as  specified  by  law,  but  to 
the  statements  which  certify  that  certain  acts  have  been  per- 
formed and  certain  facts  exist  which,  if  they  were  performed 
or  did  exist,  would  make  the  bond  a  valid  claim  in  the  hands  of 
a  bona  fide  holder.  The  statement  of  such  facts  may  not  even 
be  required  by  the  statute,  and  the  estoppel  may  merely  be 
based  on  the  fact  itself.  This  does  not,  however,  bar  the  ope- 
ration of  the  law  where  it  does  affect  these  recitals.  ' '  Nothing, ' ' 
states  one  court  decision,  "is  better  settled  than  this  rule — 
that  the  purchaser  of  bonds  such  as  these,  is  held  to  know  the 
constitutional  provisions  and  the  statutory  restrictions  bearing 
on  this  question  of  the  authority  to  issue  them ;  also  the  recitals 
of  the  bond  he  buys ;  while  on  the  other  hand,  if  he  acts  in  good 
faith  and  pays  value,  he  is  entitled  to  the  protection  of  such 
recitals  of  facts  as  the  bond  may  contain." 

As  with  other  securities  listed  on  the  stock  exchange,  a 
trustee's  certification  of  the  authenticity  of  the  issue  is 
required.2  This  is  an  excellent  added  safeguard  upon  the 
legality  of  the  few  municipals  issued,  but  only  a  very  small 
fractional  share  of  municipals  issued  ever  appears  on  the 
Exchange. 

The  approval  of  a  municipal  bond  issue  by  some  law  firm 
versed  in  municipal  law  has  been  to  the  present  time,  as  stated, 
by  far  the  most  important  indirect  guarantee  of  the  correctness 
of  the  issue  to  the  investor.  Long  experience  and  care  upon  the 
part  of  these  bond  attorneys  have  made  their  approvals  so 
accurate  that  we  accept  their  decisions  on  validity  without  fur- 
ther examination.  Increasing  standardization  and  accepted 
forms  have  made  this  more  possible.  This  approval  of  the  bond 
attorney  must  not  be  confused  with  the  certification  of  the  trus- 


'Lake  County  v.  Graham,  130  U.  S.  674,  9  Sup.  Ct.  Rep.  654,  32  L. 
Ed.  1065. 

2See  Topic  on  Exchange  Rules. 


150  INVESTMENT  ANALYSIS 

tee.  They  are  different.  The  trustee  merely  certifies  to  the 
genuiness;  the  attorney,  to  the  validity  and  the  accuracy  of  the 
issue. 

The  thing  which  is  most  to  be  desired  and  which  has  been 
slowest  in  development,  is  a  common  certification,  made  by  state 
officials  of  the  validity  of  all  civil  obligations.  Only  seven  states 
have  some  direct  or  indirect  form  of  certification.  The  earliest 
and  still  the  most  comprehensive  of  these  laws  is  that  of  North 
Dakota  (adopted  in  1889),  which  requires  that  all  civil  loans  of 
the  political  divisions  of  the  state  must  meet  the  approval  (as 
to  their  legality)  of  the  State  Attorney-General  and  receive  his 
official  certification.  They  are  then  registered  by  the  State 
Comptroller  after  which  their  validity  cannot  be  contested. 

While  it  is  true  that  the  danger  of  future  defalcations  is 
continually  decreasing,  its  entire  elimination  would  be  desirable 
and  would  be  easy  to  secure.  Thousands  of  dollars  now  needed 
annually  in  taxes  to  pay  for  the  examination  of  the  legality 
of  municipal  bonds,  could  be  saved  by  the  municipality  if 
original  authorization  and  certification  of  validation  by  some 
state  official  or  officials  were  required.  Blind  adherence  to  cus- 
tom is  probably  the  explanation.  It  is  only  a  question,  how- 
ever, of  time,  when  the  simplicity  and  the  effectiveness  of  this 
method  of  procedure  will  be  recognized. 


SECTION  I. 

A  corporation  or  municipality  issues  bonds  in  return  for 
funds  advanced.  On  the  bond  instrument  appears  a  rate  of 
interest  and  stated  dates  of  interest  payment.  This  rate  of 
interest  is  called  the  nominal  rate.  When  the  amount  author- 
ized is  to  be  issued  at  intervals,  the  rate  will  not  appear  in  the 
mortgage  because  it  may  be  necessary  to  change  the  rate  with 
each  issue  to  correspond  with  the  changes  in  market  conditions. 
Consequently,  bonds  of  the  same  authorization,  but  issued  at 
different  times,  may  appear  in  the  same  market  at  different 
rates.  This  difference  between  bonds  of  the  same  authorization 
issued  at  different  rates,  however,  will  become  adjusted  in  their 
market  price,  if  the  conditions  of  issue  are  the  same. 

Normally,  the  board  of  directors  or  issuing  body  of  a  politi- 
cal division  will  issue  bonds  at  a  rate  which  will  enable  it  to 
sell  the  bonds  at  par.  The  more  accurately  the  conditions 
which  affect  bond  values  have  been  judged,  the  less  will  the 
prices  fluctuate  in  the  market.  If  the  investment-bankers  under- 
writing the  issue  are  called  upon  to  give  undue  support  to  the 
market  in  order  to  sustain  it,  the  market  price  will  not  give  a 
true  reflection  of  actual  values.  Such  prices  in  a  narrow  mar- 
ket would  be  very  deceptive.  This  kind  of  market  support, 
however,  is  more  prevalent  in  speculative  issues;  a  strictly 
investment  issue  will  stand  upon  its  merits. 

The  rate  of  interest,  as  implied  in  previous  chapters,  cannot 
remain  constant.  The  competition  of  capital,  affected  by  the 
existing  current  market  conditions  and  changing  risks  peculiar 
to  the  corporation,  will  cause,  a  change  in  interest  rates,  and  the 
rates  on  bonds  will  tend  to  move  correspondingly  to  these 

151 


152  INVESTMENT  ANALYSIS 

changes.  In  the  chapters  on  Market  Influences  on  Security 
Prices,  it  is  clearly  shown  that  the  most  important  influence 
upon  the  investment  bond  rate  is  the  change  of  the  standard 
money,  i.  e.,  the  commodity  (gold)  in  which  the  rate  is  meas- 
ured. The  old  3  per  cent  corporation  bonds  issued  prior  to 
1900  cannot  find  a  market  during  the  next  decade. 

The  Net  Interest  Yields. — Bonds  are  often  bought  and  sold 
at  prices  different  from  their  par  values.  As  a  result  the  rate 
of  interest  received  by  a  purchaser  on  his  investment  is  not 
in  general  the  nominal  rate  of  the  bond,  being  precisely  the 
same  only  when  the  bond  is  bought  at  par.  The  net  interest 
yield,  when  the  price  is  not  par,  is  calculated  by  methods  illus- 
trated in  the  following  examples. 

The  simplest  case  is  that  of  bonds  known  as  perpetual  bonds, 
in  which  there  is  a  periodical  interest  payment  but  the  princi- 
pal is  never  repaid.  It  should  be  said  parenthetically  that  few 
of  these  issues  exist.  Suppose  a  perpetual  bond  of  par  value 
$100,  with  a  nominal  interest  rate  of  4  per  cent  payable  semi- 
annually  is  bought  at  104,  that  is,  for  $104.  The  semi-annual 
interest  payment  is  */2  of  4  per  cent  of  $100  or  $2.00.  To  find 
the  rate  on  the  investment  of  $104,  divide  2  by  104,  the  quotient 
is  .01923.  The  interest  rate  is  1.923  per  cent  for  a  half  year,  or 
2  X  1.923  per  cent  =  3.846  per  cent  per  annum  payable  in  semi- 
annual payments.  If  the  interest  on  the  bond  is  payable  quar- 
terly each  quarterly  payment  is  $1.00.  To  find  the  rate  on  the 
investment  of  $104,  divide  1  by  104;  the  quotient  is  .009615. 
The  interest  rate  is  .9615  per  cent  for  a  quarter  year,  or  3.846 
per  cent  per  annum  payable  quarterly.  If  the  interest  were 
payable  annually,  the  calculation  is  shorter.  Divide  4  by  104 
and  express  in  percentage.  The  result  is  3.846  per  cent  per 
annum  payable  annually.  The  answer  is  the  same  in  each  case 
except  for  the  payment  period.  It  is  well  to  note  fully  the  dif- 
ference, for  example,  between  3.846  per  cent  payable  annually 
and  payable  semi-annually.  In  the  former  case  there  is  an 
interest  payment  at  the  end  of  the  year  on  $1,000  of  $38.46. 
In  the  latter  cases  the  security  holder  has  in  his  possession  the 
first  interest  payment  of  $19.23  for  the  last  six  months  of  the 
year,  on  which  he  may  receive  interest.  If  interest  is  received 


BOND  YIELDS  153 

for  this  at  the  same  rate,  he  receives  at  the  end  of  the  year  not 
only  a  second  payment  of  $19.23  but  $0.37  additional  making 
the  total  interest  for  the  year,  $38.83. 

A  more  common  case  is  that  of  bonds  which  mature  at  a 
certain  future  date.  Suppose,  for  example,  that  a  $100  bond 
bearing  5  per  cent  per  annum,  maturing  in  20  years  is  bought 
at  $102.55.  What  is  the  net  interest  yield?  The  calculation 
differs  in  this  case  from  the  preceding  through  the  fact  that  at 
maturity  the  purchaser  receives  $2.55  less  than  he  invested. 
This  has  to  be  charged  off  against  the  annual  interest.  The 
calculation  of  the  precise  amount  thus  to  be  deducted  from  the 
interest  rate  involves  rather  technical  mathematical  formulae, 
but  tables  have  been  constructed  which  simplify  the  work,  and 
we  shall  make  use  of  them  without  discussing  the  manner  of 
their  construction.  A  standard  four-place  bond  table  is  most 
commonly  used.  When  large  sums  of  money  are  involved, 
extended  bond  tables1  should  be  used. 

All  the  factors  for  obtaining  the  yield  then  are; 

(1)  The  cost  price  of  the  bond, 

(2)  The  par  value  of  the  bond, 

(3)  The  amount  of  the  annual  interest  paid, 

(4)  The  length  of  the  interest   periods  or  number  of 

interest  periods, 

(5)  The  term  of  the  life  of  the  bond. 

Obtaining  the  Net  Yield  With  the  Use  of  the  Bond  Table. — 
On  the  sample  page  given  from  Rollins'  tables  of  bond  values 
all  the  nominal  rates  based  on  the  par  value  of  the  bond  are 
given  across  the  top  of  the  table  and  range  from  3  to  7  per  cent 
with  a  duration  of  20  years.  The  per  cents  given  in  the  left 
hand  or  first  column  are  the  net  yields,  with  the  discount  or 
premium  price  paid  according  to  the  nominal  rate  in  each  of 
the  columns  to  the  right  of  the  net  yield.  The  net  yields  are 
given  in  one-eighth,  one-tenth,  and  one-twentieth  per  cents. 


'Montgomery  Rollins,  Bond,  Stock  and  Interest  Tables  (18th  Edi- 
tion), 1912.  Lawrence  Chamberlain  also  has  an  unusually  clear  and 
complete  mathematical  analysis  of  bond  yields  and  prices  in  his  Prin- 
ciples of  Bond  Investments  (1911.  chapters  xxxiv,  xxxv,  and  xxxvl), 
which  those  interested  in  the  mathematical  construction  of  a  bond  table 
will  find  very  valuable.  For  a~more  complete  treatise  see  The  Account- 
ancy of  Investments,  by  Charles  Ezra  Sprague,  revised  by  Leroy  L.  Per- 
rine  (Ronald  Press,  N.  Y.,  1914,  p.  371). 


154 


INVESTMENT  ANALYSIS 

FBOM  ROLLINS  TABLES 
20  Year — Interest  Payable  Semi-Annually 


Per  Cent 

Per  An. 

3% 

3%% 

4% 

4%% 

5% 

6% 

7% 

2.90 

101.51 

109.06 

116.60 

124.15 

131.70 

146.80 

161.89 

3. 

100.00 

107.48 

114.96 

122.44 

129.92 

.   144.87 

159.83 

3.10 

98.52 

105.93 

113.34 

120.75 

128.16 

142.98 

157.81 

3% 

98.15 

105.55 

112.94 

120.33 

127.73 

142.52 

157.31 

3.20 

97.06 

104.41 

111.75 

119.09 

126.44 

141.13 

155.82 

314 

96.34 

103.66 

110.97 

118.28 

125.59 

140.21 

154.83 

3.30 

95.63 

102.91 

110.19 

117.47 

124.75 

139.30 

153.86 

3.35 

94.93 

102.17 

109.42 

116.66 

123.91 

138.40 

152.89 

3% 

94.58 

101.81 

109.04 

116.27 

123.49 

137.95 

152.41 

3.40 

94.23 

101.44 

108.66 

115.87 

123.08 

137.51 

151.93 

3.45 

93.54 

100.72 

107.90 

115.08 

122.26 

136.62 

150.98 

3  Vz 

92.85 

100.00 

107.15 

114.30 

121.45 

135.74 

150.04 

3.55 

92.17 

99.29 

106.41 

113.52 

120.64 

134.87 

149.11 

3.60 

91.50 

98.58 

105.67 

112.75 

119.84 

134.01 

148.18 

3% 

91.16 

98.23 

105.30 

112.37 

119.44 

133.58 

147.72 

3.65 

90.83 

97.88 

104.94 

111.99 

119.04 

133.15 

147.26 

3.70 

90.17 

97.19 

104.21 

111.24 

118.26 

133.30 

146.35 

3% 

89.51 

96.50 

103.50 

110.49 

117.48 

131.46 

145.44 

3.80 

88.86 

95.82 

102.78 

109.74 

116.70 

130.63 

144.55 

3% 

87.90 

94.81 

101.73 

108.64 

115.56 

129.39 

143.22 

3.90 

87.58 

94.48 

101.38 

108.28 

115.18 

128.98 

142.78 

4. 

86.32 

93.16 

100.00 

106.84 

113.68 

127.36 

141.03 

4.10 

85.09 

91.86 

98.64 

105.42 

112.20 

125.76 

139.32 

4% 

84.78 

91.54 

98.31 

105.07 

111.84 

125.37 

138.90 

4.20 

83.87 

90.59 

97.31 

104.03 

110.75 

124.19 

137.63 

4% 

83.27 

89.96 

96.65 

103.35 

110.04 

123.42 

136.80 

4.3'0 

82.68 

89.34 

96.00 

102.66 

109.33 

122.65 

135.98 

4% 

81.80 

88.42 

95.04 

101.65 

108.27 

121.51 

134.75 

4.40 

81.51 

88.11 

94.72 

101.32 

107.93 

121.14 

134.35 

4  V2 

80.35 

86.90 

93.45 

100.00 

106.55 

119.65 

132.74 

4.60 

79.22 

85.72 

92.21 

98.70 

105.19 

118.18 

131.16 

4% 

78.94 

85.42 

91.90 

98.38 

104.86 

117.82 

130.77 

4.70 

78.11 

84.55 

90.99 

97.43 

103.86 

116.74 

129.61 

4% 

77.57 

83.98 

90.39 

96.80 

103.20 

116.02 

128.84 

4.80 

77.02 

83.40 

89.79 

96.17 

102.55 

115.32 

128.08 

47s 

76.22 

82.56 

88.90 

95.24 

101.59 

114.27 

126.95 

4.90 

75.95 

82.28 

88.61 

94.94 

101.27 

113.92 

126.58 

5. 

74.90 

81.17 

87.45 

93.72 

100.00 

112.55 

125.10 

5.10 

73.86 

80.09 

86.31 

92.53 

98.76 

111.20 

123.65 

5% 

73.61 

79.82 

86.03 

92.24 

98.45 

110.87 

123.29 

5.20 

72.85 

79.02 

85.19 

91.36 

97.53 

109.87 

122.22 

5^4 

72.34 

78.49 

84.64 

90.78 

96.93 

109.22 

121.51 

5.30 

71.85 

77.97 

84.09 

90.21 

96.33 

108.57 

120.81 

5% 

71.11 

77.19 

83.27 

89.36 

95.44 

107.60 

119.77 

5.40 

70.87 

76.94 

83.01 

89.07 

95.14 

107.28 

119.42 

5% 

69.90 

75.92 

81.94 

87.96 

93.98 

106.02 

118.06 

5% 

68.72 

74.68 

80.64 

86.59 

92.55 

104.47 

116.38 

5% 

67.57 

73.46 

79.36 

85.26 

91.15 

102.95 

114.74 

57s 

66.43 

72.27 

78.11 

83.95 

89.78 

101.46 

113.13 

6. 

65.33 

71.11 

76.89 

82.66 

88.44 

100.00 

111.56 

BOND  YIELDS  155 

Though  the  sample  page  does  not  indicate  all  the  periods  of 
duration  used,  the  complete  tables  will  give  a  table  for  each  six 
months  period  from  six  months  to  30  years,  from  30  to  50  years 
annually,  and  from  50  to  100  years  every  five  years.  To  illus- 
trate the  uses  of  the  table :  take  a  $100  bond  bearing  5  per  cent 
with  20  years  to  run  and  purchased  at  $102.55,  what  would  the 
bond  yield?  Take  the  column  with  the  nominal  rate  of  5  per 
cent  at  the  head  of  the  column  and  run  down  the  column  until 
you  come  to  $102.55,  the  price  paid  for  the  bond.  Now  proceed 
at  right  angle  to  the  left  from  this  figure  to  the  extreme  left 
column,  which  gives  the  net  yield,  and  you  have  the  net  yield  of 
this  bond  of  4.80  per  cent. 

This  computation  is  made  from  an  abbreviated  table  which 
is  within  approximately  one  cent  of  the  $100  bond  of  20  years 
given  above.  Investment  Bankers  use  the  so-called  extended 
bond  tables,1  which  give  the  result  to  the  nearest  cent  on  each 
$1,000,000;  otherwise  the  losses  on  the  amounts  to  the  bank 
would  be  very  large  during  the  course  of  the  year.  For  a 
$1,000  bond,  the  amount  for  $100  would  be  multiplied  by  10, 
and  for  a  bond  of  any  other  denomination,  by  whatever  multi- 
ple it  is  of  one  hundred  dollars.  Where  the  extended  tables 
are  not  used  the  amount  of  the  error  given  above  should  be 
recognized  in  the  computation. 

In  the  above  problem,  it  is  assumed  that  the  bond  is  pur- 
chased upon  an  interest  payment  date.  More  often  the  pur- 
chase of  a  bond  will  be  made  on  a  date  other  than  the  interest 
date.  This  will  necessitate  the  allowance  for  accrued  interest 
to  the  seller  of  the  bond  from  the  last  interest  date  to  the  date 
of  sale.  This  accrued  interest  is  easily  obtained  from  interest 
tables  which  are  usually  included  in  all  volumes  of  bond  tables. 
Objection  is  constantly  made  by  the  uninitiated  buyer  against 
the  payment  of  this  accrued  interest,  as  he  considers  it  an  addi- 
tion to  the  price  of  the  bond  for  which  he  receives  no  reimburse- 
ment. The  repayment  is  made  to  the  buyer  of  the  bond  in  the 
interest  coupon  at  the  next  interest  coupon  payment  date.  Let 
us  assume  in  the  previous  problem  that  the  interest  payment 
dates  are  on  January  first  a*nd  July  first  and  the  bond  was  sold 


1The  abbreviated  tables  are  four-place  decimal  tables,  the  extended 
tables  eight-place  tables. 


156  INVESTMENT  ANALYSIS 

on  the  30th  of  January.  The  purchaser  is  then  only  entitled  to 
the  remaining  five  months'  interest  for  the  interest  interval 
between  January  first  and  July  first.  In  order  to  pay  the  seller 
for  the  thirty  days  (after  January  first)  during  which  he  has 
owned  the  bond,  the  interest  for  this  period  (which  is  included 
in  the  interest-coupon  for  the  whole  period)  is  indirectly 
deducted  by  adding  the  interest  for  this  period  to  the  price  of 
the  bond.  And  as  the  interest-coupon  paid  on  July  first 
includes  the  interest  for  the  full  period  of  six  months,  the  pur- 
chaser is  reimbursed  for  this  outlay  on  the  receipt  of  this  inter- 
est payment  upon  July  first.1 

In  the  problem  above  the  accrued  interest  for  thirty  days, 
i.  e.  $.4167,  added  to  the  price  of  the  bond  of  $102.55  gives  a 
total  cost  of  $102.9667.  The  total  interest  coupon  received  on 
July  first  is  $2.50  (the  yearly  amount  $5.00)  in  which  is 
included  the  .4167;  or  separating  the  amount  of  interest  due 
the  seller  January  30th  and  the  amount  due  to  the  purchaser  for 
the  five  months  he  will  have  owned  the  bond  until  his  next 
interest  payment  on  July  first,  the  net  allotment  of  the  pur- 
chaser for  his  five  months  will  be  (July  1st)  the  $2.50,  the 
amount  received,  less  his  advancement  of  .4167,  or  $2.0833. 

Considerable  confusion  arises  from  the  different  uses  of  the 
term  "flat  price"  of  bonds.  "When  the  interest  is  added  to  the 
base  price  and  the  bond  is  quoted  as  at  a  ''flat  price,"  this  term, 
of  course,  includes  the  accrued  interest.  The  rulings  of  the 
New  York  Stock  Exchange  on  income  bonds  and  bonds  pur- 
chased after  default  designate  the  "flat  price"  of  a  bond  as  the 
price  without  the  inclusion  of  the  accrued  interest;  this  gives 
a  double  meaning  to  "flat  price,'"'  if  the  previous  practice  is 
also  followed.  With  the  exception  of  bonds  purchased  after 
default  and  income  bonds,  bonds  on  the  New  York  Stock  Ex- 
change are  dealt  in  at  a  price  and  interest.  In  the  ordinary 
use  of  the  term,  "flat  price"  would  seem  to  include  price  and 
interest,  but  interest  is  never  taken  into  consideration  in  this 
sense,  and  the  practice  is  to  compute  the  interest  yield  and  to 
subtract  this  interest  and  follow  the  method  of  securing  the  net 
yield  at  a  price. 


'There  is  a  slight  loss  to  the  purchaser  of  his  interest  upon  the 
interest. 


BOND  YIELDS  157 

Net  Yields  of  Unrecorded  Bond  Table  Prices. — One  does 
not  go  far  in  the  computation  of  bond  yields  before  he  is  made 
aware  that  the  prices  at  which  bonds  are  currently  sold  on  the 
market  do  not  correspond  exactly  with  those  in  the  bond  tables. 
The  price  or  the  net  yield  will  be  between  two  prices  or  two 
net  yields,  and  this  necessitates  interpolation,  as  the  process  is 
called  in  mathematics,  to  secure  the  price  or  net  yield  of  the 
bond  price  not  appearing  in  the  bond  table. 

A  number  of  methods  of  interpolating  are  in  use  depending 
on  the  accuracy  desired.  The  simplest  one,  which  is  accurate 
enough  for  most  purposes,  especially  when  only  small  sums  of 
money,  short  periods  of  time,  and  low  rates  of  interest  are 
involved,  will  be  illustrated  by  examples.  What  is  the  net  yield 
of  a  5  per  cent  5  year  bond  purchased  at  $1,020? 

Under  the  five  year  table  in  the  5  per  cent  column,  the  price 
of  102  is  between  the  tabulated  prices1  of  101.77  with  a  yield 
of  4.60  per  cent,  and  102.22  with  a  yield  of  4.50  per  cent.  The 
net  yield  of  the  bond  at  102  must  then  be  somewhere  between 
4.60  and  4.50  per  cent;  which  may  be  approximated  by  pro- 
portion. 

Price  of  bonds  below  Price  of  Bond 

and  above.  Purchased. 

102.22 minus 102 leaves  .22 

101.77 from 102 leaves  .23 

.45 

The  total  difference  in  the  two  prices  on  either  side  of  the 
price  of  the  bond  purchased  is  .22  plus  .23  equals  .45. 

Price  of  bonds  above  and  below.  Net  Yields 

102.22 , 4.50 

101.77 4.60 

4.60  —  4.50  =  .10 

The  difference  in  the  net  yield  for  these  two  prices  is  .10 
which  corresponds  to  a  difference  of  .45  in  the  prices.  The 
yield  is  seen  to  be  nearer  to  4.50  than  to  4.60.  The  difference 
between  the  actual  yield  and  4.50  is  given  by  proportion: 
22  :  .45  =  X  :  .10. 


*In  all  of  the  problems  of  this  chapter,  the  Montgomery  Rollins  four 
place  tables  have  been  used.  This  must  be  observed  in  comparing  the 
same  problems  computed  with  the  eight  place  tables, 


158  INVESTMENT  ANALYSIS 

The  result  is  X  =  .05,  taking  the  nearest  number  in  the  sec- 
ond decimal  place.  Hence  the  yield  is  4.50  -|-  .05  =  4.55  per 
cent.1 

TTie  Price  of  a  Bond  Where  the  Net  Yield  Does  Not  Appear 
in  the  Bond  Table. — Again,  the  method  of  proportion  is  essen- 
tial in  securing  the  result.  Suppose  a  40  year,  5  per  cent  $1,000 
bond  is  purchased  to  yield  4.16,  what  is  the  price?  The  two 
nearest  net  yields  above  and  below  this  net  yield  in  the  bond 
table  are  4.125  and  4.20  per  cent,  with  prices  of  $1,170.70  and 
$1,154.40. 

Subtracting  the  yield  above  and  below  the  one  to  be  obtained, 
we  have:  4.20  minus  4.125  which  equals  .075. 

Subtracting  the  price  of  the  bonds  above  and  below  at  these 
net  yields,  we  have : 

$1,170.70  minus  $1,154.40  which  equals  $16.30. 

Then  .075  is  the  yield  for  $16.30  for  the  period. 

The  nearest  yield  to  4.16  is  4.125  and  the  difference  .035. 

The  proportion  then  is :    .075    :  .035    :    :  16.30   :  X. 

X  equals  $7.61,  the  amount  which  yields  .035.  Subtracting 
this  $7.61  from  $1,170.70,  the  known  price  of  the  bond  yielding 
4.125,  the  price  of  the  bond  yielding  4.16  is  procured :  $1,170.70 
minus  $7.61  equals  $1,163.09  (the  price  of  the  bond). 

While  this  result  receives  full  commercial  acceptance,  the 
proportion  or  interpolation  method  in  finding  an  unrecorded 
price,  as  with  finding  an  unrecorded  yield,  is  slightly  inaccur- 
ate. This  inaccuracy  increases  with  the  length  of  duration  and 
the  increase  of  the  premium,  but  decreases  with  the  shorter 
maturities  and  with  discount  bonds.  For  methods  of  correct- 
ing these  slight  errors  not  recognized  in  ordinary  practice,  the 
reader  is  again  referred  to  Sprague.' 

Use  of  Bank  Discount. — Banks  purchasing  bonds  having  less 


JAs  this  is  not  a  mathematical  treatise  on  investments,  it  is  the  pur- 
pose in  this  chapter  only  to  cite  the  more  essential  forms  of  computation 
ordinarily  used.  The  reader  desiring  a  more  exhaustive  treatment  of 
the  mathematics  of  investments  is  referred  to  such  works  as  Sprague 
and  Perrine  previously  cited. 

'Charles  Ezra  Sprague,  Extended  Bond  Tables  (1909),  see  explana- 
tory contents  in  preface.  Also  see  Accountancy  of  Investments,  by  the 
same  author. 


BOND  YIELDS  159 

than  twelve  months  to  run  or  short  time  notes,  do  not  use  bond 
tables  for  securing  the  net  yield  or  price  of  a  bond:  instead, 
they  use  bank  discount.  This  gives  a  slight  advantage  to  the 
banker,  as  the  money,  in  addition  to  the  interest  earned  on  the 
amount  invested,  earns  the  interest  on  the  discount. 

What  would,  for  example,  be  the  difference  in  price  of  a 
4  per  cent  $5,000  bond  having  three  months  to  run  when  the 
price  is  computed  on  the  basis  of  the  bank  and  bond  discounts 
respectively  at  4  per  cent,  as  applied  to  the  principal. 

Base  Price  Discount  Price 

Principal  at  Matur-  Principal $5,000.00 

ity $5,000.00         Discount 50.00 

Base  price  6  months 

before  maturity..     4,950.50  Discounted  price...  $4,950.00 
(Present  worth) 

Interest  on  discount 
Interest  on  base  price        49.50  price    49.50 


Principal    $5,000.00  Price  to  Banker. .  $4,999.50 

(Discounted  Price)  $4,950  plus  (Interest)  $49.50  equals  $4,999.50 
(Ultimate  cost  to  banker).  (Principal  at  Maturity)  $5,000  minus 
$4,999.50  equals  50c  (Profit  to  banker). 

Again,  assuming  a  6  per  cent  $5,000  bond  having  six  months 
to  maturity,  what  would  be  the  difference  in  the  price,  if  sold 
to  yield  5  per  cent  or  if  sold  at  a  discount  of  5  per  cent  to  a 
banker  ? 

Basis  Price  Discount  Price 

Principal  at  Matur-  Principal $5,000.00 

ity    $5,000.00  Interest  at  maturity       150.00 

Base   price   for   six 

months  to  net  5%     5,024.50  $5,150.00 

Discount  @  5%  for 
G  months  .                   12S.75 


Discounted  price...  $5,021.25 

$5,024.50  minus  $5,021.25  equals  $3.25. 

Interest  on  $3.25  for  6  montlfs  at  5  per  cent  per  annum  equals  .0812. 

$3.25  plus  .0812  equals  $3.3312  (profit  to  banker). 


160  INVESTMENT  ANALYSIS 

SECTION  II. 

Bonds  which  are  purchased  above  or  below  par,  as  maturity 
approaches,  automatically  decline  or  increase  to  par,  the  price 
at  which  they  are  paid  off  by  the  issuing  corporation.  Conse- 
quently, in  a  premium  or  discount  bond,  the  purchaser  for  an 
investment  must  make  allowance  for  this  decrease  or  increase 
in  order  to  keep  his  original  principal  invested  intact.  "With 
the  purchaser  of  a  bond  for  speculative  purposes  this  is  not 
essential,  as  he  is  only  concerned  in  the  profit  he  can  secure 
through  the  fluctuation  in  prices  of  the  principal,  usually  over 
short  periods.  The  same  principle  in  buying  and  selling  is 
followed  by  the  speculator  in  securities  as  by  the  dealer  in 
commodities.  In  an  investment,  a  bond  is  purchased  for  the 
primary  purpose  of  its  income ;  and  as  an  investment,  the  orig- 
nal  capital  is  permanent,  though  the  bond,  like  anything  which 
must  be  sold  in  the  market,  is  subject  to  market  fluctuations. 
These  fluctuations,  however,  can  be  computed  with  considerable 
mathematical  accuracy.  As  far  as  the  purchaser  is  concerned, 
these  fluctuations  have  no  bearing  upon  either  principal  or 
income,  if  the  bond  is  held  until  maturity.  If,  however,  the 
holder  of  the  bond  decides  to  sell  his  bond  upon  some  future 
date,  the  price  of  the  bond  (assuming  the  market  is  constant) 
purchased  at  par  or  discount  will  be  the  present  worth  of  the 
principal  from  the  particular  date  of  sale  to  the  date  of  matur- 
ity. The  book  value  upon  the  different  interest  payment  dates 
of  a  premium  or  discount  bond  is  computed  by  amortization  for 
premium  bonds  and  accumulation  for  discounted  bonds.  As 
one  banking  firm  defines  amortization:  " Amortization  ...  is 
the  gradual  charging  off  and  extinction  of  the  premium  paid  for 
a  bond,  by  setting  aside  at  each  interest  period  a  certain  amount 
of  the  fixed  interest  the  bond  bears,  the  amounts  set  aside  being 
so  calculated  that  at  the  maturity  of  the  bond  they  will  equal  the 
premium  paid."  If  a  new  purchaser  obtains  the  bonds,  this 
net  return  is  then  the  same  as  the  previous  holder  received  at 
the  price  which  he  paid. 

The   statutes   of   New   York   affecting   savings   banks   now 


Guaranty  Trust  Company  (N.  Y.  pamphlet),  Amortization,  p.  1. 


BOND  YIELDS  161 

require  that  profits  be  paid  only  after  "providing,  in  a  man- 
ner approved  by  the  superintendent  of  banks,  for  the  amor- 
tization or  gradual  extinction  of  premiums  or  discounts  on  all 
securities. ' ' a 

Also  "respecting  trust  companies  .  .  .  stocks  or  bonds  .  .  . 
shall  not  be  valued  .  .  .  at  a  higher  price  or  value  than  their 
investment  value  as  determined  by  amortization,  etc."a  This 
requirement  should  be  placed  by  every  state  on  every  financial 
institution,  such  as  banks,  insurance  companies,  building  and 
loan  associations  which  possess  funds  that  are  more  or  less 
held  in  public  trust.  A  good  deal  of  litigation  which  has  been 
necessitated  through  the  failure  of  wills  to  define  clearly  prin- 
cipal and  interest  could  have  been  easily  avoided.  If,  for  exam- 
ple, the  premium  on  bonds  so  purchased  is  not  to  be  set  aside 
out  of  income  to  extinguish  this  premium  at  maturity,  the  will 
should  so  state.  Whether  a  bond  is  to  be  sold  or  not,  any  finan- 
cial institution  or  any  individual  who  pretends  to  keep  an  accur- 
ate account  of  affairs  must  adopt  the  method  of  accumulation 
and  amortization  as  the  basis  of  an  accounting  system. 

The  most  frequent  makeshift  for  the  allowance  of  the  pre- 
mium or  bond  discount  is  to  permit  this  amount  to  remain  on 
the  books  at  the  original  cost  price  until  maturity  and  then  to 
add  or  write  off  in  a  lump  sum  the  total  amount  of  the  discount 
or  premium.  There  is  no  need  to  discuss  the  inaccuracies  of 
such  an  accounting  system ;  they  are  obvious.  Another  common 
practice  among  some  accountants  is  to  write  these  amounts  off 
to  profit  and  loss.  While  this  will  give-  an  accurate  result  of  all 
combined  accounts,  it  gives  no  account  of  the  profit  of  a  par- 
ticular bond  sold.  Lump  estimates  can  be  made,  but  lump  esti- 
mating is  tabooed  in  every  other  line  of  endeavor;  why  should 
it  be  continued  in  financial  accounts  where  accuracy  is  most 
essential?  It  is  in  view  of  these  suggestions  that  this  schedule 
for  computing  book  values  is  given. 

Book  Values  on  Interest  Payment  Dates  of  Bonds  Purchased 
at  a  Premium. — If  a  bond  is  purchased  at  a  premium,  the  rate 
of  interest  actually  earned  is  less  than  the  nominal  rate  of  the 


Section  123. 
Section  159. 


162  INVESTMENT  ANALYSIS 

bond.  To  secure  the  price  of  a  bond  purchased  at  a  premium, 
as  already  stated,  the  cost,  the  par  value  of  the  bond,  the  amount 
of  the  interest  paid,  the  length  of  the  interest  periods  or  num- 
ber of  interest  periods,  and  the  duration  of  the  bond  must  be 
known.  With  these  facts,  the  price  of  a  bond  purchased  at  a 
premium  can  be  determined  by  reference  to  the  bond  tables. 
The  procedure  is  best  illustrated  by  a  problem. 

If  a  bond  on  January  1,  1916,  of  the  par  value  of  $1,000 
bearing  interest  at  5  per  cent  payable  semi-annually  and  matur- 
ing in  three  years  is  purchased  for  $1,028.00,  the  yield  or  in- 
vestment basis  is  4  per  cent  (see  previous  topic  for  method  of 
computation).  With  $1,028.00  as  the  principal  with  a  yield  of  4 
per  cent  the  total  amount  of  interest  received  on  the  next  inter- 
est payment  of  July  1,  1916,  would  be  $20.60,  the  amount  which 
should  be  credited  to  the  holder  of  the  bond  as  income.  The 
balance  left  after  deducting  this  amount  from  the  actual  cash 
income  of  $25  received  leaves  $4.40,  which  should  be  credited  to 
the  sinking  fund  with  the  other  sinking  fund  allowances  to  can- 
cel the  premiums  at  the  maturity  of  the  bond.  In  this  instance 
the  investment  book  value  for  July  1,  1916,  will  then  be  the  dif- 
ference between  the  book  value  of  the  purchase  price  and  the 
amortization  fund  of  the  period;  i.  e.,  $1,028.00  minus  $4.40 
which  equals  $1,023.60.  In  this  same  manner  the  sinking  fund 
and  investment  value  for  each  period  are  determined  for  the 
interest  payment  date.  The  total  sinking  fund  at  any  particu- 
lar interest  date  is  the  sum  of  all  the  funds  set  apart.  The  total 
capital  account  or  principal,  as  related  to  the  particular  bond 
— the  bond  accounts  should  indicate  this  at  any  interest  date — 
would  be  the  book  value  of  the  bond  on  that  particular  date 
plus  the  accumulated  sums  of  the  sinking  funds. 

These  book  values  and  amortization  or  sinking  fund  require- 
ments can  be  found  even  more  readily  by  the  use  of  bond  tables. 
The  amount  of  the  amortization  for  any  particular  period  is 
determined  by  subtracting  the  book  value  on  any  interest  date 
from  the  book  value  on  the  previous  interest  date.  In  the  prob- 
lem just  used  the  first  book  value  is  $1,028.00.  By  turning  to 
the  pages  of  the  bond  table  in  turn  headed  3,  2,y2,  2,  iy2i 
1/2  years  and  checking  down  the  column  headed  by  the  nominal 


BOND  YIELDS  163 

rate  5  per  cent  to  the  price  given  in  that  column  opposite  the 
4  per  cent  net  yield  in  the  left  column,  we  have  the  book 
value  for  each  one  of  these  interest  payment  dates.  In  the 
problem  above  (represented  in  the  complete  schedule  below), 
the  book. value  on  January  1,  1916,  is  $1,028.00  and  on  July  1, 
1916,  it  is  $1,023.60;  and  the  difference  between  these  two  book 
values  is  $4.40,  the  amortization  sinking  fund.  As  the  cash 
interest  payment  is  constant,  the  net  income  is  obtained  by 
subtracting  the  amortization  sum  from  the  cash  interest.  The 
cash  interest  being  $25.00,  the  formulas  would  be  $25.00  minus 
$4.40,  which  equals  $20.60.  Thus  the  interest  received  equals 
the  net  interest  plus  the  amortization,  either  in  the  computation 
of  an  individual  period  or  in  the  total  of  these  sums  at  matur- 
ity which  verifies  the  final  result. 

If  there  is  more  than  one  bond  of  the  same  issue  the  various 
items  in  the  schedule  below  would  be  multiplied  by  the  number 
of  bonds. 

Schedule  for  a  Premium  Bond.     (Par  of  Bond  $1,000) 

Date  Semi-annual  Semi-Annual  Amortization     Book  Value 

Cash  Int.          Net  Int.  Fund 

214  per  cent    2  per  cent 

Jan.  1,  1916  $1,028.00  (Cost  of  Bond) 

July  1,  1916 $25.00  $20.60  $4.40          1,023.60 

Jan.  1,  1917 25.00  20.40  4.60          1,019.60 

July  1,  1917 25.00  20.40  4.60          1,014.40 

Jan.  1,  1918  ....     25.00  20.30  4.70          1,009.70 

July  1,  1918 25.00  20.20  4.80          1,004.90 

Jan.  1,  1919 25.00  20.10  4.90          1,000.00    (Par  Value  of 

—       Bond) 

$150.00  $122.00  $28.00 

True  interest  plus  Amortization  equals  cash  interest. 

$122.00  plus  $28.00  equals  $150.00. 

$1,000,  i.  e.,  the  amount  received  at  maturity  plus  the  total  amortiza- 
tion fund  equals  the  original  cost  of  bond,  *.  e.,  $1,000  plus  $28.00  equals 
$1,028.00. 

Book  Values  on  Interest  Payment  Dates  of  Discount  Bonds. 
— If  a  bond  is  purchased  at  a  discount  the  net  yield  to  the  buyer 
is  more  than  the  nominal  rate  of  the  bond.  Instead  of  writing 
off  a  required  amount  to  provide  for  the  cancellation  of  the 
premium,  an  accumulation  fund  must  be  charged  against  the 
bond  and  credited  to  the  ineome  account  to  offset  the  increasing 
of  the  bond  as  it  approaches  maturity. 


164  INVESTMENT  ANALYSIS 

Again  illustrating  the  principal  by  a  problem:  Assume  a 
bond  on  January  1,  1916,  of  the  par  value  of  $1,000  bearing 
interest  at  4  per  cent,  payable  semi-annually  and  maturing  in 
3  years  is  purchased  for  $972.50,  which  makes  the  net  yield  on 
the  investment  5  per  cent.  The  amount  of  the  semi-annual 
payments  on  the  investment  of  $972.50  would  then  be  $24.30. 
Subtracting  from  this  latter  sum  the  cash  interest  of  $20.00 
received,  the  accumulation  fund  of  $4.30  is  secured.  The  book 
value  on  July  1,  1916,  is  the  original  book  value  of  $972.20  plus 
the  accumulation  fund  of  $4.30  which  equals  $976.80,  the  basis 
for  securing  the  net  yield  for  the  next  interest  period.  The 
book  value  of  the  bond  on  any  interest  date  is  then  the  original 
purchase  price  plus  the  accumulation  funds  of  the  previous 
periods. 

The  book  value  on  each  succeeding  interest  date  approaching 
maturity  is  increased  by  the  amount  of  the  accumulation  fund, 
which  is  found  by  subtracting  the  last  book  value  from  the  pre- 
vious book  value.  Adding  this  difference  to  the  actual  cash 
interest  received  gives  the  net  yield.  The  addition  of  all  the 
previous  sums  at  any  interest  payment  date  will  equal  the  total 
accumulation,  which  if  added  to  the  purchase  price  will  also 
give  the  book  value.  In  the  schedule  constructed  below  the 
book  value  or  purchase  price  on  January  1,  1916,  according  to 
the  bond  table  is  $972.50;  on  July  1,  1916,  it  is  $976.80.  The 
difference  between  the  book  values  on  these  respective  dates  is 
$4.30,  which  is  the  accumulation  fund.  This  latter  amount 
($4.30)  plus  the  cash  interest  of  $20.00  received,  equals  $24.30, 
the  actual  net  yield  to  be  credited  to  the  holder  of  the  bond. 
While  the  $4.30  is  not  received  in  cash  at  this  particular  date, 
it  does  represent  the  present  value  of  the  sum  to  be  received  at 
maturity  by  the  holder,  which  is  after  all  what  the  accumula- 
tion fund  purports  to  set  forth.  If  the  cash  interest  alone  is 
credited  to  the  holder,  he  does  not  receive  the  credit  for  the 
full  amount  due  upon  the  actual  cash  investment  made.  Fur- 
thermore, if  the  accumulation  is  not  considered,  a  profit 
accrues  at  maturity,  and  this  accrued  profit  must  be  charged  to 
surplus. 


BOND  YIELDS  165 

Schedule  for  a  Discount  Bond  (Par  of  Bond  $1,000) 

Date               Semi-annual  Semi-Annual  Amortization  Book  Value 

Cash  Int.        True  Int.          Fund 
2  per  cent    2l/2  per  cent 

Jan.  1,  1916  $    972.50  (Cost  of  Bond) 

July  1,  1916 $20.00        $24.30        $4.30  976.80 

Jan.  1,  1917 20.00          24.40          4.40  981.20 

July  1,  1917 20.00          24.50           4.50  985.70 

Jan.  1,  1918 20.00          24.70           4.70  990.40 

July  1,  1918 20.00          24.70           4.70  995.10 

Jan.  1,  1919 20.00          24.90          4.90  1,000.00  (Par  Value) 


$120.00      $147.50       $27.50 

True  interest  minus  the  accumulation  equals  the  cash  interest. 

$147.50  minus  $27.50  equals  $120.00. 

$1,000,  i.  e.,  the  amount  received  at  maturity  minus  the  total  accumu- 
lation funds  equals  original  cost  of  the  bond ;  $1,000  minus  $27.50  equals 
$972.50. 

Bonds  Purchased  on  Other  Than  Interest  Dates. — It  is  an 
exception  rather  than  a  rule  that  a  bond  is  purchased  on  a  regu- 
lar interest  date.  The  common  practice  is  to  compute  the 
accrued  interest  and  adjust  the  price  to  the  interest  payment 
dates.  As  a  majority  of  the  corporation  reports  are  rendered 
on  January  and  July  1st  and  the  income  tax  and  savings  bank 
reports  are  required  on  the  same  dates,  it  facilitates  the  work 
on  the  accounts  in  the  corporation  to  keep  the  amortization 
accounts  uniformly  adjusted  to  these  dates. 

To  illustrate  the  purchase  of  a  bond  on  an  odd  date,  assume 
that  the  previous  premium  bond  was  purchased  on  the  first  of 
March,  1919.  The  amortization  for  the  bond  must  be  found 
from  March  1,  to  July  1,  1919,  a  period  of  four  months.  To  ob- 
tain this,  find  the  true  interest  for  this  period  at  4%  upon  the 
cost  price  of  the  bond,  $1,026.58,  and  deduct  it  from  the  cash 
interest  due  (i.  e.,  on  $1,000  at  5%  per  annum  for  four  months) 
which  will  give  the  amortization  for  the  period  of  four  months. 
The  interest  for  four  months  on  $1,026.58  at  4%  is  $13.69  and 
at  5%  on  the  par  is  $16.68  and  the  difference  between  the  two 
is  $2.98.  As  this  now  adjusts  the  accounts  to  the  regular  interest 
dates,  the  procedure  to  be  followed  in  the  construction  of  the 
schedule  is  the  same  as  that  which  was  employed  in  the  former 
problem. 


166  INVESTMENT  ANALYSIS 

Schedule  for  a  Premium  Bond  Purchased  at  an  Odd  Date 

Date  Semi-annual  Semi-Annual  Amortization      Book  Value 

Cash  Int.        True  Int.          Fund 
2l£  per  cent    2  per  cent 

Mar.  1,  1916 $16.68  $13.68  $2.98  $1,026.58  (Cost  of  Bond) 

July  1,  1916 25.00  20.40           4.60  1,023.60 

Jan.  1,  1917  ....     25.00  20.40           4.60  1,019.00 

July  1,  1917 25.00  20.30           4.70  1,014.40 

Jan.  1,  1918 25.00  20.20           4.80  1,009.90 

July  1,  1918 25.00  20.10           4.90  1,004.90 

Jan.  1,  1919 —  1,000.00    (Tar  Value  of 

$141.68  $115.08  $26.58  -  Bond) 

True  interest  ($115.08)  plus  amortization  ($26.58)  equals  ($141.66), 
the  cash  interest.  Principal  paid  ($1,000.00)  plus  amortization  ($26.58) 
equals  $1,026.58,  the  original  investment. 

When  the  bonds  are  issued  and  mature  at  other  than  the 
accustomed  dates  used  in  business  practice  and  the  dates 
required  for  state  reports,  the  schedule  will  have  to  be  made 
without  the  use  of  the  bond  tables.  Where  this  necessity  arises, 
the  first  method  as  applied  to  Schedule  I  alone  can  be  applied ; 
i.  e.,  multiplying  the  investment  value  at  an  irregular  period 
by  the  irregular  net  rate  for  that  period  to  obtain  the  net 
income.  This  sum  added  to  or  subtracted  from  the  coupon  in- 
terest according  to  whether  it  is  a  premium  or  discount  bond 
will  give  the  amortization  or  accumulation.  This  sum  whether 
derived  from  a  regular  or  irregular  period,  if  added  or  sub- 
tracted, as  the  case  may  be,  will  give  the  investment  value  for 
the  next  period. 

If  the  bond  can  be  called  in  at  the  will  of  the  borrower 
before  a  stated  time,  the  difference  (at  the  time  the  bond  is 
called)  between  the  amount  received  and  the  investment  value 
should  be  charged  to  profit  or  loss  as  the  case  may  be.  In  all 
other  cases  the  problem  of  amortization  and  accumulation  in 
the  optional  bond  is  the  same  as  that  already  discussed. 

The  Serial  Bond  Schedule. — The  total  cost  of  the  serial  bond 
or  bonds  will  be  the  sum  of  the  costs  of  each  bond  or  group 
of  bonds.  The  cost  of  each  bond  is  based,  as  before,  upon  the 
rates  and  dates  of  their  respective  maturities.  The  common 
practice  is  to  obtain  serial  bond  prices  by  averages,  which  is 


BOND  YIELDS  167 

always  inaccurate.     The  total  costs  of  the  bonds  of  all  maturi- 
ties are  secured  by  the  addition  of  the  separate  maturities. 

With  the  cost  basis  established,  the  schedule  will  be  con- 
structed, as  before,  to  the  first  maturity.  With  the  maturity 
of  each  serial  payment,  the  par  value  of  this  is  added  to  the 
amount  of  the  amortization  for  that  interest  payment  and  sub- 
tracted from  the  investment  value  of  the  previous  date  for  a 
premium  bond  and  added  to  a  discount  bond.  This  gives  the 
investment  value  of  the  bond  for  the  next  period.1 


irThe  use  of  even  months  as  divisor  in  determining  the  amount  of 
the  interest  will  always  work  to  a  slight  disadvantage  to  the  buyer. 


CHAPTER  X 
MARKET  INFLUENCES  ON  SECURITY  PRICES 

It  is  very  difficult  to  draw  the  line  of  demarcation  between 
investment  and  speculation  when  one  analyzes  the  influence  of 
market  conditions  on  security  prices.  Buying  and  selling  for 
profit  upon  the  basis  of  an  enhanced  price  of  the  principal  is 
admittedly  speculation.  But  can  one  say,  then,  that  purchasing 
a  security  in  an  advantageous  market  and  thus  increasing  the 
net  yield,  is  not  a  part  of  investment?  And  can  the  investor 
be  unmindful  of  the  depreciation  of  a  security  from  the  pre- 
mium at  which  it  is  purchased  before  maturity?  While  an 
investment  means  a  permanent  holding,  necessity  may  force 
liquidation  before  maturity,  in  which  case  a  price  fluctuation, 
affecting  the  principal,  is  of  paramount  importance.  Certainly, 
no  one  can  deny  the  necessity  of  examining  those  factors,  exter- 
nal to  the  security,  which  affect  the  stability  of  the  principal.1 
To  avoid  a  consideration  of  the  relation  of  the  financial  markets 
to  investment  securities  in  a  study  of  investments  would  be 
very  much  like  the  miller's  disregarding  the  price  of  wheat. 

There  are  too  many  influences  at  work  for  one  to  be  able  to 
determine  always  and  absolutely  what  will  be  the  trend  of 
security  prices.  There  are,  however,  certain  big  factors  and 
relationships  which  are  based  on  fundamental  causes  and  which 
do  indicate  tendencies  in  the  market  affecting  the  long  time 
fluctuations  in  market  price  (not  the  short  speculative  fluctua- 
tions). The  word  "tendencies"  is  used  advisedly,  as  the  incom- 
pleteness of  the  data  relative  to  security  prices  warrants  only 

1Rapports  sur  les  Indices  des  Crises  economiques  et  sur  Mesures 
financiers  peopre  i  atttinuer  les  Chdmages  resultant  de  Crises  (French 
Government  Report,  1911,  p.  78).  See  also  Warren  M.  Persons,  Con- 
struction of  a  Business  Barometer  Based  Upon  Annual  Data,  Amcr. 
Econ.  Rev.,  vol.  vi.,  Dec.,  1916,  pp.  739-7G9.  Also  same  author's  Studies 
in  Harvard  Bureau  Economic  Statistics,  vol.  i,  1919. 

168 


MARKET  INFLUENCES  169 

an  assumption  of  tendencies.     This  is  borne  out  by  the  fol- 
lowing : 

First,  the  only  considerable  complete  data  on  security 
prices  are  of  the  prices  of  securities  listed  on  the  stock  exchange, 
though  such  limited  observations  as  have  been  made  of  unlisted 
security  prices  indicate  the  same  general  tendency.  Secondly, 
bonds  and  notes  of  varying  maturities,  other  things  being  equal, 
are  not  influenced  to  the  same  degree  by  the  same  market  con- 
ditions. Short  termed  maturities  are  less  susceptible  to  change 
in  price  than  long  termed  securities.  Thirdly,  as  stated  by 
Wesley  Mitchell  in  his  "Business  Cycles,"  "the  rising  price 
levels  have  shown  a  narrower  margin  between  higher  and  lower 
yields  in  the  past  twenty  years. ' '  Fourthly,  the  improved  physi- 
cal condition  of  properties  has  in  itself  so  strengthened  the 
credit  of  many  corporations  that  historical  comparisons  are 
often  impractical.1  Fifthly,  the  factors  influencing  market 
prices  never  repeat  themselves  in  exactly  the  same  manner. 
The  resultant  then  must,  necessarily,  show  some  variations.  As 
all  factors  making  up  the  market  influences  are  constantly  fluc- 
tuating, and  each  new  combination  gives  a  slightly  different 
result,  it  is  only  safe,  as  stated  in  the  beginning,  to  stipulate 
that  certain  tendencies  exist.  This  does  not,  however,  deny  the 
existence  of  fundamental  laws  which  influence  security  prices. 
For  illustration,  Professor  Irving  Fisher  states  that  "no  one 
ever  has  seen  a  complete  demonstration  of  Newton's  law  of 
falling  bodies. ' '  Neither  has  any  one  seen  the  law  operate  from 
time  to  time  in  exactly  the  same  manner.  The  most  costly  and 
most  frequent  error  made,  as  all  students  of  market  conditions 
fully  realize,  is  that  of  drawing  deductions  upon  insufficient 
data.  Even  to  determine  tendencies,  a  complete  composite  view 
of  all  data  must  be  had.  To  quote  Wesley  Mitchell  again,  ' '  The 
uncertainty  attending  present  forecasts  of  business  conditions 
arises  chiefly  from  the  imperfections  of  our  knowledge  concern- 


Mitchell.  Business  Cycles  (University  of  California  Press. 
1913).  pp.  156-157.  The  reader  will  also  find  instructive  the  conclusions 
of  this  same  author  on  general  prices  as  related  to  the  war  in  the 
"History  of  Prices  During  the  War"  (Summary),  War  Industries  Board 
(Bulletin  No.  1,  Washington  Government  Printing  Office,  1919,  pp. 
01-95). 


170  INVESTMENT  ANALYSIS 

ing  these  conditions  in  the  immediate  past  and  in  the  present. 
For  since  business  cycles  result  from  processes  of  cumulative 
change,  the  main  factors  in  shaping  tomorrow  are  the  factors 
at  work  yesterday  and  today. ' ' 

The  unwarranted  disrepute  into  which  the  forecasting  of  busi- 
ness conditions  has  fallen  is  due  to  the  ignorant  or  wilful  abuse 
that  has  too  often  been  made  of  facts.  Too  many  men,  discov- 
ering a  parallel  between  two  sets  of  facts  or  noticing  that  one 
condition  follows  another,  immediately  conclude  that  a  rela- 
tion of  cause  and  effect  exists.2  There  may  be  no  relationship 
between  the  two  facts,  the  parallelism  being  a  mere  chance  coin- 
cidence. Too  frequently,  it  is  to  be  feared,  ignorance  of  simple 
statistical  facts  has  led  to  prediction  of  impossible  happenings. 

Interest3  and  Discount  Rates. — The  call  loan  rate4  has  been 
termed  "the  safety  valve"  of  the  money  market.  At  the  same 
time  that  "call  loans  are  the  storehouse  for  the  surplus  money 
of  the  country,"  the  immediate  demand  that  can  be  made  upon 
call  loans  makes  the  call  loan  rate  the  most  sensitive  of  all  in- 
terest rates  to  market  fluctuations.  In  a  forced  liquidation  of 
the  market,  the  immediate  burden  of  disbursement  falls  upon 
call  money,  with  an  equally  responsive  recovery  and  lowering 
of  the  rate  when  liquidation  has  been  completed.  "Thus  by 
their  reliance  on  stock  exchange  quotations  as  measuring  the 
true  value  of  the  stock  collateral  which  they  hold,  the  banks 
build  up  the  very  exchange  prices  on  which  they  rely  to  lend, 
and  again,  when  they  are  in  strained  positions,  they  themselves 

"Ibid.  The  student  will  also  find  Melvin  T.  Copeland's,  Statistical 
Indices  of  Business  Conditions  of  value,  pp.  98-132.  (In  Business  Statis- 
tics, Harvard  University  Press,  1917.)  Also  see  Roger  W.  Babson, 
Business  Barometers  Anticipating  Business  Conditions  (Tenth  edition, 
Wellesley  Hills.  Mass..  1917),  chapter  iv.  J.  H.  Brookmire,  Methods 
of  Forecasting  Based  on  Fundamental  Statistics  (American  Economic 
Review,  volume  iii,  No.  1,  March,  1913,  pp.  43-59). 

"See  Horace  Secrist,  An  Introduction  to  Statistical  Methods  (N.  Y., 
Macmillan  &  Co..  1917,  pp.  425-431),  for  illustrations. 

"For  a  theoretical  discussion  of  the  interest  rate  and  its  influences, 
see  Irving  Fisher's,  The  Rate  of  Interest  (N.  Y.,  Macmillan  &  Co.,  1907). 

*The  call  loan  referred  to  above  is  the  call  loan  used  in  the  financial 
money  markets — i.  e.,  it  is  "the  form  of  a  note  or  promise  to  pay,  the 
borrower  having  the  right  to  pay  off  the  loan  at  any  time — presumably 
not  the  same  day  it  is  made — and  likewise  the  lender  the  right  to 
demand  payment."  In  practice  the  lending  banker  practically  always  is 
the  one  who  calls  the  loan. 


MARKET  INFLUENCES  171 

destroy  those  very  prices.  Here  then,  is  one  of  the  main  causes 
of  the  priority  of  our  stock  market  declines  to  commercial 
troubles;  the  banking  strain  seeks  relief  by  throwing  off  stock 
market  burden  by  liquidation,  and  in  so  doing  crumbles  the 
stock  exchange  quotations.  Only  a  minor  part  of  the  matter 
can  be  granted  to  those  traders  who,  foreseeing  and  accom- 
panying with  their  commitments  the  genuine  sales  brought 
about  by  the  banks'  demands,  sell  stock  short  to  accelerate  the 
decline. ' ' 

Discounts  always  follow  closely  in  the  wake  of  the  call  loan 
recovery,  and  a  business  revival  does  not  proceed  very  far  before 
discount  rates  advance,  though  the  complete  recovery  is  usually 
slower  than  the  recuperation  of  general  prices. 

Interest  rates  on  long  time  securities  recover  more  slowly 
than  discount  rates.  In  either  case,  however,  relatively  cheap 
money  rates  generally  exist  prior  to  any  extensive  upward  ten- 
dency of  security  prices,  or  general  prosperity.  This  variation 
between  the  discount  and  the  interest  rates  is  only  a  logical 
development  of  a  general  business  recovery.  Recovery  first 
occurs  in  the  current  business  which  is  undertaken  without  the 
aid  of  additional  financing,  but  which  necessitates,  before  it  has 
proceeded  far,  the  assistance  of  the  commercial  bankers  in  dis- 
counting its  current  paper.  The  bankers  with  the  accumulation 
of  reserves,  after  the  complete  liquidation  of  the  market,  can 
usually  meet  the  curbed  commercial  and  industrial  demands  for 
current  loans  without  materially  weakening  their  condition. 

A  sudden  upward  movement  of  interest  rates  occurs  just 
before  a  severe  strain  in  the  market,  because  of  the  sharp 
demand  for  credit  and  at  the  same  time  an  increased  demand 
for  the  payment  of  loans.  And  not  until  this  strain  has  been 
relieved  by  complete  liquidation  can  permanently  lower  rates 
normally  be  expected.  Where  radical  exceptions  occur,  in  either 
a  rising  or  falling  rate,  the  cause  can  be  attributed  to  some  other 
unusual  condition.  For  example,  there  was  a  great  difference 
of  interest  rates  before  the  panics  of  1903  and  1907,  the  rate  in 
the  year  preceding  1907  being  almost  double  the  rates  in  1902 
and  1903.  Prior  to  the  colkpse  of  1903,  it  was  very  easy  for 
us  to  obtain  money  in  Europe,  but  in  1907  Europe  had  difficulty 


172  INVESTMENT  ANALYSIS 

in  meeting  its  own  demands.  However,  it  is  self-evident  that 
no  very  important  and  long-continued  rise  can  occur  in  a  mar- 
ket until  relatively  cheap  interest  rates  have  been  firmly  estab- 
lished. It  is  only  when  the  market  gathers  the  momentum  of 
renewed  stability,  under  the  expansion  of  business,  that  invest- 
ment bankers  are  warranted  in  guaranteeing  the  advancement 
of  funds  for  fixed  investments.  As  expressed  in  the  market 
term,  "money  must  be  cheap"  before  the  market  will  long  con- 
tinue to  absorb  securities. 

The  temporary  fluctuations  of  discount  and  collateral  loan 
rates,  which  may  be  of  wide  range,  must  not  be  confused  with 
the  more  permanent  movements  of  the  financial  markets.  The 
sensitiveness  of  discount  and  collateral  loan  rates  to  temporary 
influences  makes  it  difficult  to  determine  from  their  changes 
whether  a  speculative  and  temporary  fluctuation  or  a  permanent 
movement  exists  in  security  prices.  For  this  reason  long  time 
rates  are  more  accurate  indicators  of  the  permanent  market 
trends. 

Every  investor  is  cognizant  of  the  rising  price  level  which 
has  forced  a  corresponding  demand  for  a  larger  investment 
yield.  Railroads  for  several  years  following  the  panic  of  1907 
participated  in  the  "waiting  policy"  by  issuing  short  term  notes 
with  the  hope  that  interest  rates  would  decline.  But  the  great 
expansion  of  industrials  and  especially  public  utilities,  together 
with  the  increasing  municipal  issues,  forced  a  partial  readjust- 
ment of  interest  rates  to  the  basis  of  the  rising  price  level. 
With  the  persistency  with  which  prices  have  been  rising  since 
1896,  it  would  seem  rather  futile  to  expect  longer  the  low  inter- 
est rates  that  were  so  common  in  high  grade  securities  of  the 
early  nineties.  On  the  contrary,  increased  pressure  on  prices 
growing  out  of  the  European  War,  temporarily  at  least,  has 
tended  to  force  them  to  higher  levels. 

Several  authorities  have,  however,  raised  the  issue  as  to 
whether  the  low  rates  on  long-time  securities  are  not  merely 
nominal.1  E.  W.  Kemmerer  in  his  discussion  of  the  "War  and 
Interest  Rates"  states: 


*See  Proceedings  of  the  American  Bankers  Association  for  1918  ana 
the  Proceedings  of  the  American  Economic  Association  for  1918.  Also 
see  Irving  Fisher's,  the  Equation  of  Exchange  for  1913  to  1918.  The 
American  Economic  Review,  vol.  ix,  No.  2  (June,  1919),  pp.  407-411. 


MARKET  INFLUENCES  173 

bought  our  low  interest  rates  at  the  price  of  very  high 
prices;  we  kept  rates  down  by  pushing  price  levels  up.  The 
government  was  enabled  to  borrow  at  low  interest  rates  partly 
also  by  policies  which  led  to  tremendous  inflation.  .  .  .  Both  the 
government  and  the  public  paid  lower  nominal  rates  of  interest 
than  they  otherwise  would  have  paid,  by  reason  of  this  situa- 
tion ;  but  it  does  not  follow  that  they  will  pay  lower  amounts 
of  interest,  for  the  very  policies  that  kept  interest  rates  down 
pushed  prices  up  and  the  borrower  was  accordingly  compelled  to 
pay  higher  prices  and  thereby  borrow  larger  sums  of  money 
than  he  otherwise  would  to  buy  the  same  supply  of  goods.  .  .  . 
If  the  next  few  years  witness  a  gradual  deflation  of  our  currency 
and  credit — and  the  purchasing  power  of  the  dollar  rises,  the 
debtors  will  be  required  to  pay  their  debts — principal  and  inter- 
est— in  more  valuable  dollars  than  they  borrowed.  This  agio 
in  the  value  of  the  dollar  they  will  repay  over  the  value  of  the 
dollar  they  borrowed  will  be  part  of  the  interest  rate,  but  they 
will  not  recognize  it  as  such.  It  is  likely  to  make  the  actual  or 
purchasing  power  interest  rates  on  long-time  loans,  floated 
during  the  war  period  very  big  ones." l 

While  conditions  involved  in  the  above  illustration  are  par- 
tially historical,  the  extremes  represented  in  the  relationships 
of  this  experience  are  much  more  easily  seen,  because  of  the  very 
rapidity  of  their  movements,  than  are  the  slower  but  similar 
changes  during  normal  periods.  The  principle,  however,  is  no 
different  from  what  would  be  the  slower  operation  of  the  same 
factors  under  peace  conditions. 

The  experiences  of  1920  in  the  relationship  of  interest  rates 
to  security  prices  have  been  instructive.  With  the  policy  of 
the  Federal  Reserve  Board,  after  the  signing  of  the  armistice,  of 
continuing  the  low  rates  until  January,  1920,  credit  inflation 
continued.  With  the  fall  in  prices  which  followed  the  raising 
of  the  rates  a  speculative  rise  in  securities  took  place.  The 
"market  tipsters"  immediately  drew  the  conclusion  that  a  long 
continued  upward  movement  of  security  prices  was  imminent. 
The  movement  was  merely  a  temporary  speculative  swing  with- 
out a  fundamental  basis  which  would  cause  a  long  continued 
upward  movement,  and  it  again  collapsed  in  April.  The  gen- 
eral market  was  still  inflated,*  and  no  long  continued  swing,  as 


*E.  W.  Kemmerer.  The  War  and  Interest  Rates.  The  American  Eco- 
nomic Review  (Annual  Proceedings),  vol.  ix,  pp.  106-107. 


174  INVESTMENT  ANALYSIS 

already  suggested  can  take  place  under  these  conditions,  though 
a  temporary  speculative  swing  may.  The  recognition  of  this 
inflation  and  the  changing  relationship  of  interest  rates  and 
prices  were  further  illustrated,  especially  by  large  investment 
buyers  during  the  year  (1920).  Not  until  the  market  had  suffi- 
ciently adjusted  itself  so  that  corporations  could  issue  new 
bonds  at  higher  rates,  did  these  buyers  make  extensive  purchases 
in  the  market. 

Loans,  Deposits  and  Reserves. — The  influence  of  credit  on 
security  prices  is  more  direct  than  that  of  any  other  factor  in 
the  market.  But,  to  insure  clarity  in  the  discussions  of  the 
items  determining  the  condition  of  credit,  it  must  be  borne  in 
mind  that  increasing  deposits  do  not  necessarily  mean  an 
increase  in  cash.  If  it  were  possible  to  represent  separately  on 
a  bank  statement  the  ratio  of  the  loans  to  credit  deposits  and 
the  ratio  of  loans  to  cash  deposits  in  the  bank,  undoubtedly 
many  of  the  common  mistakes  of  interpreting  these  items  would 
not  be  made.  When  a  loan  is  made,  that  amount  is  seldom  paid 
in  cash,  but  the  account  of  the  borrower  is  credited  with  this 
amount,  which  then  becomes  a  deposit  in  the  bank ;  i.  e.,  the 
whole  transaction  is  a  credit  operation.  The  only  legal  limita- 
tion placed  upon  this  operation  is  the  requirement  that  the 
bank  maintain  a  certain  ratio  of  reserve  to  deposits. 

The  amount  of  loans  and  discounts  indicates  the  demand  for 
credit,  and  deposits  show  the  supply  of  credit ;  and  deposits  are 
limited  by  the  amount  of  the  reserve  required  by  the  banks. 
The  advantage  in  using  the  ratio  of  loans  to  deposits  to  express 
the  condition  of  credit  is  that  the  same  relation  is  expressed 
between  demand  and  supply,  whether  it  is  the  result  of  con- 
tracting of  cash  deposits,  as  in  1893,  or  the  over-expansion  of 
loans,  as  in  1903,  1907,  or  1918-1921.  The  fact  that  the  total 
volume  of  loans  to  deposits  may  change  does  not  destroy  the 
purpose  of  the  ratio. 

If  the  ratio  of  specie  to  deposits  is  increasing  and  loans  are 
growing  correspondingly,  it  is  indicative  of  a  healthy  condition 
of  the  banks.  If  the  ratio  of  loans  and  discounts  to  deposit  is 
high  and  the  ratio  of  specie  to  deposits  is  small  or  rapidly 
decreasing,  they  usually  indicate  an  inflated  condition  of  the 


MARKET  INFLUENCES  175 

banks.  This  will  necessitate  either  a  check  in  business  or  a 
liquidation  of  the  market.  If  the  ratio  of  loans  and  discounts 
to  deposits  is  low,  the  ratio  of  reserves  to  deposits  is  large  they 
indicate  both  that  the  market  has  been  liquidated  and  that  bank- 
ing conditions  are  in  a  strong  position. 

Now,  how  do  these  conditions  specifically  affect  bond  prices? 
If  an  average  index  price  that  has  been  compiled  for  high  class 
bonds  be  compared  with  the  ratio  of  loans  to  deposits,  the  com- 
parison normally  will  show  that  when  the  former  is  low,  the 
latter  ratio  will  be  high,  and  vice  versa.  And  the  more  stable 
the  security  of  the  principal  is,  the  more  closely  does  it  respond 
to  the  fluctuations  of  credit,  though  there  are  conditions  as  indi- 
cated under  other  topics  of  this  chapter  when  this  relationship 
will  be  modified.  The  same  holds  true  in  the  financing  of  the 
new  issues.  If  the  ratio  of  loans  to  deposits  is  low  and  the  per- 
centage of  reserves  to  deposits  high,  normally  credit  is  cheap 
and  it  is  profitable  to  buy  bonds  with  borrowed  funds.  In  a 
reverse  credit  market,  as  little  or  no  profit  would  be  made  in 
buying  bonds  with  borrowed  money,  the  price  of  bonds  would 
tend  to  fall  in  order  to  correct,  to  a  measure,  the  ratio  between 
the  net  yield  of  the  bonds  and  market  rate  of  interest. 

If  the  surplus  is  large,  a  considerable  demand  can  be  made 
on  its  resources  without  seriously  affecting  the  bank's  entrench- 
ments, as  such  a  demand  would  if  the  reserve  were  low.  Too 
small  a  reserve  or  a  deficit  indicates  a  strained  condition  of  the 
bank,  or  an  overly  optimistic  market  which  must  soon  readjust 
itself.  Not  only  can  no  new  loans  be  made,  but  it  forces  the 
immediate  liquidation  of  securities  carried  on  collateral.  Viewed 
in  another  way,  it  is  the  effect  on  the  market  of  the  supply  and 
price  of  money. 

Any  comparison  of  bank  reserves  of  the  present  with  any 
period  prior  to  1914  must  allow  for  the  decrease  in  the  required 
legal  reserve.  Prior  to  the  adoption  of  the  Federal  Eeserve  Act 
in  1913,  surplus  reserve,  the  amount  of  reserve  carried  above 
the  legal  requirements,  gave  an  immediate  check  on  the  strength 
of  the  bank.  The  amount  of  the  surplus  reserve  also  indicated 
whether  a  long  term  market- movement  was  possible.  But  the 
surplus  reserve  has  become  a  criterion  of  questionable  value 


176  INVESTMENT  ANALYSIS 

under  the  Federal  reserve  system,  because  of  the  ease  with  which 
reserves  may  be  created  through  rediscounting  at  Federal 
Reserve  Banks  (and  with  the  great  variations  in  the  govern- 
ment 's  calls  on  its  balances  at  banks,  thereby  reducing  the  banks 
Federal  reserve  balances). 

A  comparison  of  bank  reserves  of  the  present  with  any 
period  prior  to  1914  must  allow  for  the  decrease  in  the  legal 
reserve  now  required.1  Under  the  amendment  of  June  21,  1917, 
to  the  Federal  Eeserve  Act  the  full  amount  of  this  legal  reserve 
of  the  member  banks  must  be  deposited  with  the  Federal 
Reserve  Banks  of  their  respective  districts.  Thus  the  gold 
reserves  are  retained  within  their  respective  districts  and  are 
not  tied  up  in  the  larger  money  markets,  where  they  were  for- 
merly primarily  used  in  loans  for  speculation.  This  should 
eventually  give  greater  stabilization  to  the  investment  market, 
if  the  spirit  of  the  law  is  followed.  While  it  is  quite  clear  that 
the  change  from  a  decentralized  to  a  centralized  system  should 


luUnder  the  old  national  banking  system,  as  we  have  seen,  for  every 
dollar  in  actual  cash  added  to  reserves  the  banks  could,  on  the  average, 
increase  deposits  and  hence  loans  and  discounts  eight  dollars.  Since, 
however,  a  cash  reserve  of,  say,  12  per  cent  appeared  as  a  legal  reserve 
of  20  per  cent  (because  of  interbank  reserve  deposits,  one  dollar  cash 
counted,  on  the  average,  as  $1.60  or  $1.70  of  legal  reserve),  a  dollar  of 
excess  legal  reserve  could  be  used  by  national  banks  in  general  as  the 
basis  for  expansion  of  five  dollars  in  loans  and  discounts.  Now,  under 
the  Federal  Reserve  system  ...  if  a  bank  in  New  York,  Chicago,  or 
St.  Louis  creates  a  credit  at  the  Federal  Reserve  Bank,  that  credit 
would  be  the  basis  for  loans  for  between  seven  and  eight  -times  the 
amount  of  the  credit.  If  a  bank  in  a  reserve  city  creates  such  a  credit 
it  has  a  basis  for  granting  ten  times  that  amount  of  credit  to  its  cus- 
tomers, and  if  a  country  bank  creates  such  a  credit  it  has  a  basis  for 
granting  credits  to  its  customers  for  about  fourteen  times  that  amount." 
Warren  M.  Persons,  The  Review  of  Economics  and  Statistics,  Harvard 
University  Committee  on  Economic  Research,  January.  1920,  vol.  ii,  p.  22. 

Mr.  H.  L.  Reed  makes  the  amounts  $13  and  $40  respectively,  but 
he  does  not  include  till  money  in  these  amounts.  H.  L.  Reed,  Credit 
Expansion  under  the  Federal  Reserve,  American  Economic  Review,  vol. 
viii,  June,  1918.  p.  274. 

Edwin  W.  Kemmerer  illustrates  this  expansion  as  follows :  Assum- 
ing each  bank  below  has  $1.200,000  demand  deposits,  $300,000  of  time 
deposits  and  $100,000  of  national  bank  notes  outstanding : 

Bank  in  Per  Cent         Amount      Per  Cent    Amount 

Central  Reserve  City 25  $375.000.00        4.18        $62,750 

Reserve  City   15.6          234,375.00        3.34          50,150 

Country  7.4          111,093.75        2.50          37,550 

E.  W.  Kemmerer,  High  Prices  and  Inflation  (Princeton  University  Press. 
1920),  p.  16. 


MARKET  INFLUENCES  177 

make  for  a  more  effective  use  of  each  dollar  in  the  reserve,  there 
may  be  danger  of  inflation  of  credit  in  too  great  a  reduction  of 
reserve  requirements.  The  experience  of  the  banks  under  the 
old  act  clearly  indicated  that  the  banks  normally  kept  their 
reserves  close  to  the  minimum  legal  requirement,  and  the  ex- 
perience under  the  Federal  Reserve  requirements  thus  far  indi- 
cates that  the  minimum  requirement  will  probably  be  closely 
followed. 

The  depositing  of  all  legal  reserves  of  member  banks  in  the 
Federal  Reserve  Bank  of  their  district  should  assist  in  a  more 
effective  separation  of  the  purely  speculative  and  the  strictly 
commercial  banking  credit.  That  is  the  gold  which  normally 
flowed  in  large  amounts  at  certain  periods  and  seasons  to  the 
New  York  market  is  kept  within  the  district.  Much  of  the 
effectiveness  of  this  use  of  the  gold  fund,  needless  to  say,  will 
depend  upon  the  administration  of  it.  Any  discussion  of  bank 
loans,  deposits  and  reserves  must  include  at  least  a  mention  of 
inflation,  which  was  probably  the  most  frequently  mentioned 
financial  term  during  the  period  of  1917-1920.  For  twenty 
years  prior  to  this  and  quite  apart  from  any  war  influences,  the 
expansion  of  currency  and  "circulating  credit"  was  in  excess 
of  the  increase  of  business.  At  the  outbreak  of  the  War  in  1914 
this  increase  was  still  in  progress.  According  to  Irving  Fisher's 
approximations,  the  volume  of  business  increased  138  per  cent 
and  the  volume  of  gold  over  200  per  cent.  While  gold  produc- 
tion was  slowed  up  by  war  conditions,  the  even  greater  expan- 
sion in  ' '  circulating  credit ' '  more  than  offset  the  decrease  in  the 
reduction  of  gold  production. 

Many  have  thought  inflation  could  arise  only  where  an  excess 
of  paper  money  was  issued,  as  during  the  Civil  War.  The  last 
war  experience  clearly  demonstrated  that  too  much  gold  as  well 
as  too  much  circulating  credit  can  as  effectively  inflate  prices  as 
too  much  paper  money.  The  volume  of  gold  in  the  United 
States  imported  from  August  1,  1914,  through  the  war  period 
was  over  one  thousand  million  dollars.  A  more  important 
factor  was  the  changes  in  the  Federal  banking  system,1  which 

JSee  the  Federal  Reserve  Act  of  1913  as  amended  August  15,  1914, 
aud  June  21,  1917. 


178  INVESTMENT  ANALYSIS 

reduced  the  reserve  requirements  thus  allowing  a  much  greater 
credit  expansion.1  This  act  reduced  reserve  requirements  to  less 
than  one-fifth  the  requirements  before  1914.*  Another  contrib- 
utary  force  in  the  expansion  and  greater  use  of  gold  at  this 
time  was  the  issuance  of  Federal  Reserve  notes  which  largely 
replaced  the  gold  certificates  and  only  required  a  40  per  cent 
gold  reserve.  The  establishment  of  the  gold  settlement  fund 
and  the  clearing  and  collection  system  also  gave  a  more  effective 
use  to  money  in  circulation. 

While  these  changes  in  the  banking  system  have  operated 
under  financial  pressure  of  the  War  and  the  adjustment  period 
following,  the  potential  possibilities  of  a  much  larger  circulating 
credit  than  under  the  old  system  exist.  A  long  experience  in 
the  operation  of  the  system,  however,  is  necessary  to  gauge  its 
full  influence  on  the  money  and  security  markets. 

Another  agency  which  should  have  some  influence  upon  the 
credit  market  for  securities,  particularly  the  speculative  market, 
is  the  stock  clearing  corporation.  As  this  organization  was 
only  put  into  operation  May  1,  1920,  it  is  also  not  yet  possible 
to  judge  its  importance  or  influence  on  the  speculative  security 
market.  Without  question  a  number  of  additional  important 
changes  will  be  made  in  the  next  few  years  in  the  methods  of 
advancing  loans  for  speculative  purposes. 

In  conclusion,  let  the  fact  be  emphasized  concerning  bank 
funds  that  before  any  real  upward  trend  in  the  market  (bull 
market)  can  be  sustained,  bank  statements  must  show  large 
available  funds  to  carry  on  the  bull  campaign.  This,  together 
with  lowering  interest  rates,  usually  means  that  an  increased 
demand  for  investment  securities  will  take  place.  The  unwar- 
ranted depletion  of  funds  has  the  opposite  effect  of  creating  an 
overstrained  market.  This  result  is  brought  about  by  over-zeal- 
ous banks  in  their  attempts  to  reap  large  profits. 

Bank  Clearings. — Formerly  the  clearings  of  banks,  exclusive 
of  those  of  New  York,  were  a  more  accurate  indicator  of  general 


*E.  W.  Kemmerer,  Causes  and  Progress  of  Inflation,  Proceedings  of 
the  Academy  of  Political  Science,  volume  ix  (June,  1920),  p.  9.  (The 
whole  of  this  issue  of  the  Proceedings,  which  is  devoted  to  Inflation 
and  High  Prices,  is  instructive.) 

'Ibid. 


MARKET  INFLUENCES  179 

business  activity  than  were  the  clearings  which  included  those 
of  New  York  banks,  as  speculation  in  securities  in  the  New  York 
market  forms  a  larger  percentage  of  the  business  transactions 
than  in  any  other  market  in  the  country.  Large  fluctuations 
may  exist  in  a  speculative  market,  while  no  great  activity  or 
change  is  taking  place  in  general  business  activities.  An 
acceptance  of  New  York  clearings,  therefore,  was  not  a  very 
accurate  barometer  of  the  general  financial  market,  especially  if 
the  New  York  market  was  in  the  midst  of  a  very  speculative 
market.  The  establishment  of  the  Federal  Eeserve  system  of 
clearings  and  collections,  and  the  increasing  diversion  of  checks 
from  regular  clearing  channels  through  the  Federal  Eeserve 
clearing  system,  have  rendered  outside  clearings  of  dubious 
value  as  a  criterion  in  recent  years.  The  bank  debits  issued 
currently  in  the  Federal  Reserve  Bulletin  are  now  far  more 
suggestive. 

As  the  London  clearings  are  reported  every  two  weeks,  and 
not  daily  as  in  New  York,  London  clearings  reflect  fairly  closely 
general  business  conditions,  while  they  reflect  less  accurately 
the  condition  of  the  immediate  speculative  market.  In  the  other 
large  countries  of  Europe,  because  of  the  more  limited  use  of 
the  check  system,  bank  clearings  represent  such  a  small  per- 
centage of  the  total  transactions  that  they  can  be  given  little 
weight. 

If  the  total  amount  of  clearings  has  increased  in  one  period 
over  a  previous  one,  accompanying  an  upward  trend  of  the 
general  price  level,  the  clearings  of  the  later  date  should  be 
discounted  to  the  amount  of  the  increase  in  general  prices.  It 
is  not  an  uncommon  practice  among  users  of  mechanical  devices 
in  constructing  their  graphs  for  illustrating  the  growth  of  busi- 
ness, not  to  make  any  allowance  for  the  change  in  the  price 
level. 

Import  and  Export  of  Gold. — When  specie  is  being  exported 
from  a  country,  general  prices  normally  tend  to  fall,  and  exports 
of  goods  are  eventually  stimulated.  Vice  versa,  if  specie  is 
being  imported,  general  prices  normally  tend  to  rise  and 
imports  increase.  An  automatic  regulator  of  this  flow  of  gold 
is  the  discount  rate.  As  the  movement  develops  in  either  direc- 


180  INVESTMENT  ANALYSIS 

tion  above  or  below  the  normal,  the  discount  rate  tends  to  rise 
or  fall  and  check  the  export  or  import  of  gold. 

To  determine  the  movement  of  gold  in  the  trade  relations  of 
one  country  with  another,  it  is  necessary  to  credit  it  not  only 
with  the  export  of  commodities,  but  with  interest  on  loans,  ocean 
freight  charges,  commissions,  loans  from  foreign  countries,  the 
amount  brought  by  immigrants,  letters  of  credit  and  capital 
invested  and  debited.1  Gold  will  flow  in  either  direction  to  an 
amount  necessary  to  adjust  any  additional  liabilities.  Hence, 
it  is  not  an  adjustment  between  exports  and  imports,  but 
between  debit  and  credit  balances.  It  is  thus  possible  for  a 
country  to  have  an  excess  of  either  visible  exports  or  imports, 
and  the  credit  or  liability  may  be  adjusted  through  one  of  the 
other  sources. 

A  large  part  of  these  balances  between  the  United  States 
and  Europe,  in  the  past,  has  been  made  by  the  movements  of 
securities  between  the  two  markets.  These  settlements  are  made 
in  the  same  way  as  in  the  local  markets :  by  the  re-sale  of  secur- 
ities outstanding,  or  by  the  sale  of  new  issues.  In  the  former 
instances,  international  balances  are  not  infrequently  adjusted 
by  the  sending  of  securities  instead  of  specie;  consequently 
securities  which  have  a  wide  distribution  abroad  will  be  the  first 
to  reflect  any  large  changes  in  exchange  rates.  If,  for  exam- 
ple, large  imports  were  being  made  and  interest  and  discount 
rates  were  high,  it  would  be  profitable  to  send  securities  abroad, 
or  vice  versa.  With  the  large  demand  for  capital  in  the  United 
States,  the  sale  of  new  securities  has  always  furnished  a  very 
large  balance  in  the  settlement  of  international  balances  of 
trade.  And  to  that  extent  they  have  affected  the  rates  of  for- 
eign exchange,  which  in  turn  affect  the  local  trade.  The  closer 
this  relationship  is  in  any  particular  market,  the  more  quickly 
it  will,  of  course,  react.  Japan,  which  was  building  up  a  large 
balance  against  us  in  1916,  forced  a  decided  change  in  the 

1C.  K.  Hobson.  The  Export  of  Capital  (The  Macmillan  Co.,  N.  Y., 
1914),  chap,  vii  (the  student  will  find  the  reading  of  the  whole  of  this 
volume  instructive).  See  also  the  even  more  extensive  study  of  Charles 
Bullock,  John  H.  Williams,  and  Rufus  S.  Tucker,  The  Balance  of  Trade 
of  the  United  States,  The  Review  of  Economic  Statistics  and  Supple- 
ments, vol.  i,  Harvard  University  Committee  on  Economic  Research 
(1919),  pp.  215-266, 


MARKET  INFLUENCES  181 

exchange  rate  against  the  United  States  in  the  summer  of  that 
year.  Even  had  the  German  peace  rumors  of  1916  not 
appeared,  this  changing  condition  would  have  eventually  forced 
a  change  in  the  stock  market. 

At  times,  a  faulty  monetary  system,  a  lack  of  confidence  in 
the-  securities  of  a  country,  or  a  desire  to  increase  gold  holdings, 
quite  apart  from  the  normal  market  influences,  may  destroy  the 
equilibrium  of  these  normal  operations  in  financial  conditions. 
From  1890  to  1896  the  distrust  abroad  of  the  security  of  our 
gold  standard  caused  a  large  amount  of  our  securities  held  there 
to  be  thrown  on  the  New  York  market  with  a  consequent 
increase  of  the  gold  outflow.  A  continued  high  level  of 
exchange  rates,  which  cannot  be  justified  by  the  normal  factors 
in  exchange,  generally  would  indicate  a  large  sale  of  European 
holdings  of  American  securities.  For  example,  the  high 
exchange  rate  in  Europe  against  Germany  for  several  months 
prior  to  the  declaration  of  war  in  1914  was  chiefly  caused  by 
Germany's  efforts  to  increase  its  gold  supply  in  preparation  for 
the  war  that  seemed  imminent,  while  the  New  York  rate  was 
considerably  aggravated  by  the  concealed  selling  of  European 
holdings,  which  greatly  depressed  the  price  of  securities. 

On  the  immediate  outbreak  of  the  War,  the  United  States 
bankers  were  more  than  ever  embarrassed  by  the  demand  of 
Europe  for  settlement  in  gold.  The  common  practice  of 
bankers  in  the  United  States  is  to  make  large  loans  in  the  spring 
and  summer  seasons,  and  then  to  make  payment  with  the  cotton 
and  cereal  bills  in  the  fall.  With  the  declaration  of  war, 
shipping  was  paralyzed,  and  the  United  States  bankers  were 
forced  to  make  shipment  in  gold.  Moreover,  the  Allied  bankers 
were  insisting  on  payment  in  gold.  By  the  middle  of  Novem- 
ber, 1915,  sterling  exchange  was  about  normal,  but  conditions 
were  rapidly  developing  that  soon  changed  all  this.  Before 
the  end  of  1914,  shipping  conditions  were  much  changed,  and 
it  was  realized  that  the  Germans  could  only  succeed  to  a  lim- 
ited extent  in  demolishing  shipping;  the  English  moratorium 
was  eased  up,  and  unparalleled  orders  for  goods,  clothing,  and 
war  supplies  were  placed  in*  this  country.  The  whole  energy  of 
both  England  and  France  was  devoted  to  war  production  and 


182  INVESTMENT  ANALYSIS 

they  had  few  goods  to  exchange  for  the  goods  purchased.  They 
had  only  three  important  methods  by  which  they  could  pay :  (1) 
by  the  shipment  of  gold,  to  which  there  was  a  very  definite  limit ; 
(2)  by  the  resale  of  American  securities,  which  at  first  was 
over-estimated;  and  (3)  by  the  procuring  of  credit  through 
securing  loans  in  the  United  States. 

In  making  these  settlements,  English  bankers  desired  two 
things  most:  (1)  the  maintaining  of  a  high  price  for  American 
securities,  which  they  desired  to  sell,  and  (2)  a  low  interest  rate 
for  the  loans  they  desired  to  float.  So  what  at  first  seemed  to  the 
average  American  in  the  early  years  of  the  War  unfortunate  for 
Great  Britain  was  to  its  advantage.  These  conditions  were 
affected  by  the  shipment  of  large  quantities  of  gold.  The  same 
advantage  obtained  for  England  in  keeping  the  American 
securities,  which  were  mobilized  and  used  as  collateral  for  loans. 
These  large  shipments  of  gold,  together  with  the  expansion  of 
credit  under  our  Federal  Reserve  system,  just  entering  into 
operation  at  this  time,  established  low  interest  and  discount 
rates,  and  a  strong  security  market.  The  disadvantage  was 
eventual  inflation.  A  close  study  of  the  gold  shipments  of  Eng- 
land during  the  entire  war  period  also  indicates  that  there  was 
no  hesitation  when  necessity  arose  for  the  shipment  of  gold. 
Financial  interests  of  the  United  States  saw  the  danger  existing 
to  both  the  United  States  and  the  Allies  in  the  continued  accept- 
ance of  gold,  and  as  a  result  greater  effort  was  made  both  in 
the  purchase  of  American  securities  and  the  extension  of  loans. 

This  chapter  in  the  history  of  gold  movements  is  without 
parallel ;  yet  the  movement  was  not  so  entirely  new  and  unusual 
as  has  sometimes  been  stated.  The  underlying  causes  forcing 
these  war  gold  movements  did  not  differ  from  the  pre-war  gold 
movements  except  that  the  former  was  made  on  an  enormous 
scale;  and  their  magnitude  alone  made  them  unusual  in  their 
effect  on  the  security  market. 

The  problem  in  the  United  States  during  the  first  years  of 
the  War  was  not  how  to  avoid  tight  money,  but  how  to  keep 
funds  of  the  bank  loaned  at  a  profitable  rate,  and  at  the  same 
time  not  to  allow  too  great  a  stimulation  to  the  speculative 
market.  By  the  early  part  of  the  summer  of  1915,  the-competi- 


MARKET  INFLUENCES  183 

tion  among  banks  for  the  lending  of  their  funds  had  become  very 
keen.  But  by  the  end  of  1915,  the  large  expansion  of  business 
and  the  demand  for  funds  from  abroad  began  to  absorb  this 
large  surplus,  though  the  profits  from  this  increase  in  business 
made  more  funds  available. 

Miscellaneous  Factors. — Imports1  show  the  general  trend  of 
existing  trade  during  periods  of  prosperity ;  but  during  periods 
of  depression  they  normally  fall  off  at  more  than  a  correspond- 
ing ratio.  In  the  use  of  statistics  for  comparative  purposes  in 
this  connection  the  influence  of  trade  restriction  and  regulation 
must  not  be  omitted.  Export  statistics  of  the  United  States 
are  very  much  less  reliable  in  indicating  the  situation  of  our 
own  market,  because  of  the  inadequate  methods  used  for  col- 
lecting these  statistics;  also  the  preponderance  of  our  exports 
are  raw  products,  which  are  not  as  good  a  criterion  of  the  finan- 
cial market  as  the  exports  of  manufactured  products  would  be. 
Conditions  abroad,  which  also,  at  times,  dominate  exports,  may 
not  always  be  very  accurate  indicators  of  our  own  financial 
market.  Immigration2  figures,  while  important  to  individual 
corporations,  have  little  value  in  pre-indicating  market  trends, 
as  they  respond  after  changing  conditions  are  well  under  way. 
As  economic,  political,  and  social  conditions  in  foreign  countries 
(which  may  have  little  or  no  effect  on  the  conditions  in  the 
United  States)  may  stimulate  or  retard  the  flow  of  migration, 
their  use  for  indicating  market  conditions  is  seriously  limited. 

Railroad  gross  earnings,3  and  vessel  tonnage4  cleared  in 
United  States  ports,  like  bank  clearings,  indicate  the  present 
state  of  business  conditions  and  cannot  be  used  as  an  index  of 
the  market's  future  trend,  for  gross  earnings  continue  to 
increase  during  the  most  serious  stage  of  security  liquidation. 
The  tardiness  in  the  issuance  of  reports  will  frequently  cause  a 
considerable  variation  in  the  actual  totals  of  earnings  reported, 


1Export  and  import  statistics  can  be  found  in  the  Monthly  Summary 
of  Commerce  and,  Finance,  also  in  the  Annual  Statistical  Abstract  of  the 
Federal  Government. 

'Ibid. 

*See  the  special  monthly  supplement  issued  by  the  Commercial  and 
Financial  Chronicle  on  railroad  earnings. 

*Monthly  Summary  of  Commerce  and  Finance,  and  Commerce  and 
Navigation  of  the  U.  S. 


184  INVESTMENT  ANALYSIS 

as  a  varying  number  of  railroads  are  included  from  month  to 
month.  This,  however,  can  be  corrected  by  using  the  same 
group  of  railroads,  though  the  very  reports  wanted  may  be 
missing.  The  number  of  idle  cars,1  the  amount  of  construction 
work,  the  production  of  pig  iron,  steel  and  iron,2  coal,3  copper,4 
building  material,5  commodity,"  prices,7  and  other  basic  commodi- 
ties, fall  into  the  same  classification.  While  they  are  all  invalu- 
able indices  of  the  present  market,  and  as  a  whole  indicate  the 
possible  duration  and  permanency  of  any  market  swing,  they 
cannot  be  relied  upon  as  future  indicators  of  the  trend  in 
market  prices.  Pig  iron,  steel,  and  iron  are  the  most  valuable 
indicators  of  this  group.  As  the  orders  for  iron  and  steel  are 
booked  some  months  in  advance,  the  future  conditions  in  the 
industry  normally  can  be  ascertained  sooner  than  in  other  indus- 
tries; consequently,  they  reflect  the  present  status  a  great  deal 
more  accurately  than  any  other  single  commodity. 

As  the  United  States  for  years  has  been  an  agricultural 
exporting  nation,  a  large  crop8  has  always  had  an  immediate 


*Monthly  Reports  of  the  American  Railway  Association  (Statement 
of  Freight  Car  Balance  and  Performance.  Published  semi-mouthly  from 
Jan.,  1908,  to  Nov.,  1914,  Feb.  1,  1915,  to  date — monthly.) 

*Iron  Age,  published  weekly,  Statistical  Report  of  the  American 
Iron  and  Steel  Association,  American  Metal  Market,  and  Daily  Iron  and 
Steel  Report,  etc. 

3See  current  issues  of  the  Coal  Age. 

4See  current  issues  of  Engineering  and  Mining  Journal. 

*New  York  Journal  of  Commerce  and  Commercial  Bulletin  (Daily). 

Bradstreet's,  Dun's,  Neiv  York  Journal  of  Commerce,  Labor  Bureau 
Bulletins,  etc. 

"See  Bradstreet's,  also  Babsoris  Statistical  Desk  Chart,  which  is  an 
excellent  and  convenient  reference  for  much  of  the  statistical  material 
in  this  chapter.  This  Desk  Chart,  which  is  a  mere  tabulation  of  these 
figures,  must  not  be  confused  with  the  Market  Letters  of  this  Organiza- 
tion. The  current  index  series  of  the  Federal  Reserve  Bulletin  and  of 
the  Federal  Reserve  Bank  of  New  York  also  will  be  of  value.  E.  W. 
Kemmerer's  index  in  High  Prices  and  Inflation  (1920)  is  of  especial 
value  to  the  student  for  the  period  immediately  following  the  War.  The 
Harvard  Bureau  of  Statistics  is  .gathering  a  fund  of  material  that  is 
probably  the  most  thoroughgoing  yet  attempted. 

''New  York  Journal  of  Commerce  and  Commercial  Bulletin  (Daily). 

Bradstreet's  Dun's  New  York  Journal  of  Commerce,  Labor  Bureau 

"Publication  of  the  Bureau  of  Crop  Estimates  (Department  of  Agri- 
culture of  the  United  States)  ;  see  Circular  17  of  this  Bureau  on  Gov- 
ernment Crop  Reports;  Their  Value,  Scope  and  Preparation.  This  cir- 
cular gives  a  good  explanation  of  the  operations  of  this  Bureau. 

See  also  Bruce  Mudget  in  Business  Statistics  (1917),  Ibid. 

Annals  of  the  American  Academy  of  Political  and  Social  Science, 
vol.  xxxviii,  No.  2,  pp.  104-125. 


MARKET  INFLUENCES  185 

stimulating  effect,  and  a  crop  shortage  a  reactionary  effect  on 
general  business  conditions.  The  corresponding  change  in  the 
market  prices  of  raw  products,  especially  wheat,  corn  and 
cotton,  will  have  an  important  and  immediate  effect  on  general 
business  conditions.  But  despite  the  dependence  of  the  United 
States  upon  crops,  they  have  never  been  the  determining  cause 
of  a  long  swing  in  the  market,  and  have  no  permanent  effect  on 
the  long  swings  of  security  prices,  except  that  the  permanent 
increase  in  production  acreage  does  increase  wealth  and  income, 
which  in  turn,  increases  purchasing  power.  Large  crops,  and 
crop  shortage  of  a  particular  year,  have  a  more  immediate  effect 
upon  the  speculative  market.  The  direct  cause  of  the  long 
swings  in  the  security  market,  however,  is  the  status  of  credit. 
During  the  panic  of  1893,  crop  droughts  aggravated  the  severity 
of  the  gold  panic,  but  in  the  panics  of  1903  and  1907,  very  large 
crops,  instead  of  alleviating  conditions,  increased  the  difficulty 
because  they  increased  the  demand  for  money  for  the  movement 
of  these  crops.  In  the  autumn  of  1912,  the  large  crops  were 
the  cause  of  the  temporary  but  not  very  great  recovery  in  gen- 
eral business  conditions,  in  a  period  of  four  years  of  business 
stagnation. 


CHAPTER  XI 
MARKET  INFLUENCES  ON  SECURITY  PRICES 

(Continued) 

Seasonal  Variation.1 — The  former  inelasticity  of  the  United 
States  currency  system,  which  has  so  frequently  been  criticised, 
forced  a  recurring  seasonal  fluctuation  in  the  demand  for 
money,  hence  a  corresponding  change  in  prices.  While  the 
seasonal  fluctuations  vary  with  the  different  sections  of  the 
country,  the  fluctuations  in  the  New  York  money  market  are 
the  most  essential  ones  to  study  in  relation  to  investments. 
However,  with  the  ultimate  readjustments  that  will  probably 
take  place  under  the  Federal  Reserve  System,  the  seasonal  diffi- 
culties ought  to  be  greatly  reduced. 

The  best  seasonal  indicators  of  the  New  York  money  market 
are  those  items  which  are  most  responsive  to  quick  changes, 
namely,  call  loan  rates,  very  short  time  loan  rates,  and  the 
ratios  of  reserves  to  deposits.  Time  loans  and  bank  clearings, 
according  to  Professor  E.  "W.  Kemmerer,  while  less  susceptible 
to  minor  influences,  mark  more  accurately  the  broad  swings  of 
the  market,  but  they  are  unsafe  indicators  as  to  the  beginning 
and  ending  of  the  seasonal  swings.  The  reader  should  always 
be  careful  in  his  study  of  the  items  just  stated,  not  to  confuse 
their  seasonal  movements  with  the  movements  primarily  based 
on  the  contraction  and  expansion  of  credit  over  a  long  period. 
The  tendency  in  the  decrease  or  increase  of  interest  rates  and 
ratios  of  loans  to  deposits  and  of  reserves  to  deposits  in  the 
long-period  movements,  can  usually  be  anticipated,  but  they  are 

'All  the  subject-matter  of  this  section  has  been  summarized  from 
the  following  report :  E.  W.  Kemmerer — Variation  in  the  Demand  for 
Money,  National  Monetary  Commission,  61st  Congress,  2nd  Session,  1911. 
See  also  an  article  in  the  American  Economic  Revieiv,  volume  i,  March, 
1911,  pp.  33-49,  by  the  same  author. 

186 


MARKET  INFLUENCES  187 

not  regular  in  occurrence;  their  seasonal  movements,  on  the 
other  hand,  are  fairly  constant  in  repetition,  but  dc  not  antici- 
pate coming  changes  of  an  enduring  character  in  the  market. 
However,  if  over-expanded  credit  has  accumulated  over  a  "long- 
period  swing,"  and  exists  during  the  autumnal  seasonal  swing, 
the  strain  is  greatly  intensified. 

As  further  pointed  out  in  Kemmerer's  Congressional  report 
in  discussing  the  seasonal  swing  of  the  calendar  year,  there  is 
a  decided  easing  of  the  money  market  in  January,  which  extends 
into  February,  usually  making  a  "cheap  money"  market  at  the 
end  of  January  and  the  beginning  of  February.  The  reasons 
for  this  first  movement  are:  the  subsidence  of  crop  moving 
demand  and  the  consequent  return  of  cash  to  New  York,  the 
relatively  small  amount  of  freight  traffic  and  the  large  amount 
of  exports  in  January.  The  second  seasonal  swing  usually 
begins  somewhere  between  the  middle  and  the  last  of  February 
and  extends  into  April.  This  second  upward  movement  can 
be  chiefly  attributed  to  the  demand  for  cash  for  spring  plant- 
ing, the  renewed  building  activity,  the  payments  of  obligations 
and  interest  and  a  minor  movement  of  cash  payments  to  New 
England  manufacturers.  The  third  seasonal  swing  extends 
from  the  close  of  this  former  period  to  the  middle  of  June  or 
early  July  and  is  due  to  the  influence  of  foreign  trade,  the 
decline  in  money  rates  and  the  movement  of  money  to  New 
York  and  the  discount  in  trading  made  in  anticipation  of  the 
fall  demands.  The  fourth  movement,  marked  by  the  first  crop 
movements,  is  anticipated  by  an  upward  swing  of  call  rates 
and  a  lowering  of  bank  reserves  and  an  increase  of  loans  to 
deposits.  This  period  proceeds  into  a  fifth  movement  which  is 
largely  a  continuation  of  the  fourth,  but  with  a  more  decided 
upward  trend  about  October  first,  which  continues  well  toward 
the  end  of  the  year.  The  chief  cause  of  this  last  movement  is 
the  demand  for  cash  to  move  the  crops  and  is  sustained  by  the 
trade  activity  of  the  holidays.  .  .  . 

:'The  seasonal  effect  on  bond  prices  does  not  cause  them  to 
move  consistently,  or  regularly.  Also,  individual  prices  may 
not  fluctuate  very  much,  "but  collectively  for  the  year  these 
fluctuations  extend  into  millions.  Bond  prices  tend  to  increase 


188  INVESTMENT  ANALYSIS 

in  January  under  the  stimulus  of  an  easy  money  market  and  to 
decline  quite  steadily  till  the  climax  of  the  second  swing.  With 
the  beginning  of  the  second  weak  seasonal  market,  bond  prices 
normally  rise  to  their  highest  point  in  early  summer.  From  the 
first  of  June  until  the  first  of  September,  bond  prices  normally 
take  their  first  pronounced  downward  move  and  continue  even 
more  steadily  until  the  middle  of  November,  when  they  tend  to 
move  upward  following  an  unsteady  advance  during 
December. ' ' 1 

The  Business  Cycle? — Though  a  detailed  discussion  is  not 
possible  in  this  work,  it  is  essential  that  the  existence  of  recur- 
ring rhythmic  changes  in  the  market  and  their  effects  on 
security  prices  be  at  least  suggested,  and  the  effects  summarized. 

The  same  difficulties  are  confronted  in  determining  the 
causes  of  business  cycles,  as  in  discovering  the  causes  which 
determine  the  tendency  of  general  economic  movements.  Again, 
as  Wesley  C.  Mitchell  says  of  them,  "the  deep-seated  difficulty 
in  framing  such  a  theory  (i.  e.,  a  theory  of  crises)  arises  from 
the  fact  that  while  business  cycles  recur  decade  after  decade, 
each  new  cycle  presents  points  of  novelty.  Business  history 
repeats  itself,  but  always  with  a  difference.  This  is  precisely 
what  is  implied  by  saying  that  the  process  of  economic  activity 
with  which  business  cycles  occur  is  a  process  of  cumulative 
change. 

"It  follows  that  a  thoroughly  adequate  theory  of  business 
cycles  applicable  to  all  cases  is  unattainable.  Even  if  one  cycle 
could  be  fully  accounted  for,  the  account  would  necessarily  be 
inaccurate  with  reference  to  cycles  which  were  the  outgrowth 
of  earlier  or  of  later  conditions."8  For  illustration,  crises  or 

'Ibid,  pp.  217  and  223-224. 

2W.  C.  Mitchell,  Business  Cycles.  The  contents  of  this  section  very 
closely  follows  the  theory  of  the  business  cycle  as  stated  by  Mitchell. 

Other  useful  references  are:  Henry  Ludwell  Moore,  Economic 
Cycles  (1914)  ;  O.  M.  W.  Sprague,  History  of  Crises  Under  the  Na- 
tional Banking  System  (Tn  National  Monetary  Series)  ;  G.  H.  Hull.  In- 
dustrial Depressions  (1911)  ;  T.  E.  Burton,  Financial  Crises  (1907)  ; 
E.  D.  Jones,  Economic  Crises  (1900)  ;  J.  Gardner,  The  Investment  Aspect 
of  Financial  Stringency  (Financial  Rev.  of  Rev.,  vol.  ii.  No.  99,  Jan., 
1914,  pp.  18-27)  ;  O.  M.  W.  Sprague,  The  Crises  of  1914  in  the  U  S. 
(American  Economic  Revieiv,  vol.  v,  Sept.,  1915,  pp.  499-534.) 

3Ibid. 


MAKKET  INFLUENCES  189 

panics  are  usually  preceded  by  an  over-expansion  of  credit  and 
followed  by  a  slump,  but  this  does  not  prove  that  over-expansion 
of  credit  is  the  only  cause  or  that  it  is  an  equally  important 
factor  in  all  panics. 

The  first  results  of  an  over-strained  market  are  the  liquida- 
tion of  obligations  and  stocks  of  goods,  an  ultimate  decrease  in 
cost  prices,  a  lowering  of  interest  rates  and  of  the  ratios  of  loans 
to  deposits,  and  an  increase  of  the  percentage  of  reserves  to 
deposits.  With  the  complete  readjustment  that  results  in  lower 
prices  and  interest  rates,  hesitation  is  overcome,  and  one  factor 
after  another,  which  in  the  total  makes  for  business  activity, 
moves  forward.  While  prices  may  not  respond  with  the  same 
rapidity  all  along  the  line,  sooner  or  later  they  must  respond  to 
the  general  advance  of  prices.  Where  prices  have  advanced 
more  rapidly  than  the  general  price  level  warrants,  this  move- 
ment may  cause  a  reaction  in  certain  industries,  or  even  in  all 
industries,  as  in  1909. 

In  the  first  stages  of  business  recovery,  discount  and  interest 
rates  increase  slowly,  but  with  the  firm  establishment  of  the 
recovery,  interest  and  discount  rates  tend  steadily  upward. 
Banks  and  capitalists,  during  the  first  months  of  recovery, 
desire  only  the  safest  channels  for  the  disposal  of  their  surplus 
funds,  and  consequently  the  demand  for  securities,  is  directed 
largely  to  high  grade  bonds.  This  demand  very  soon  forces  up 
the  prices  of  these  securities,  and  as  long  as  this  demand  for 
investment  bonds  continues,  the  prices  will  continue  to  rise,  thus 
proportionately  cutting  down  the  net  yield,  though  the  upward 
trend  of  bond  prices  may  be  severely  checked  by  a  glutting  of 
the  market  with  new  issues  or  by  rapidly  rising  interest  rates. 
But  with  the  continuing  demands  of  expansion,  conservatism 
relaxes  and  a  reactionary  influence  develops  against  bond  prices ; 
i.  e.,  with  the  rising  prices  and  consequent  low  yields,  purchasers 
of  securities  demand  a  more  profitable  rate  of  return.  Conse- 
quently, many  capitalists  buy  in  the  more  speculative  lists. 
Under  the  stimulus  of  increasing  prosperity,  the  less  efficient 
enterpriser  and  the  enterprisers  already  in  business  are  induced 
to  take  greater  risks.  In  4ime,  cost  of  output  increases,  but 
prosperity  reaches  a  comparatively  high  point  before  the  cost 


i90  INVESTMENT  ANALYSIS 

of  equipment  has  made  serious  inroads  on  profits.  This  expan- 
sion of  new  enterprisers  creates,  in  turn,  an  increased  demand 
for  more  loans,  and  under  the  stimulus  of  this  new  impetus 
savings  are  brought  out.  With  the  rise  in  profits,  ths  price  of 
securities  closely  follows,  the  scale  increasing  at  a  relatively 
faster  ratio  as  the  speculative  risk  increases. 

When  this  movement  has  reached  its  high  tide,  corporations 
tend  to  give  up  bond  issues  and  resort  to  short  termed  notes  and 
stocks,  with  the  purpose  of  waiting  for  lower  interest  rates 
before  making  a  long  time  bond  issue.  Where  over-indulgence 
in  this  method  of  financing  has  been  practiced,  it  greatly  inten- 
sifies the  general  pressure  in  a  strained  market.  And  under 
the  same  stimulus  new  contracts  are  made  which  call  for  fur- 
ther expansion. 

With  the  centralizations  of  gold  reserves,  the  control  of  the 
discount  rate  by  the  Federal  Eeserve  Board,  and  the  elasticity 
possessed  by  the  asset  currency  of  the  Federal  banking  system, 
these  cycles  should  be  greatly  minimized. 

Banks  are  the  first  to  feel  the  pressure  of  the  increased 
demand  for  short  time  loans,  and  it  is  in  this  demand  that  we 
have  the  first  intimation  of  a  coming  stringency.  When  the 
demand  for  loans  begins  to  exceed  the  supply  of  available  bank 
funds,  and  the  rates  go  up,  the  profits  of  corporations  begin  to 
decline  with  the  increased  costs.  Under  these  circumstances 
corporations  like  public  utilities  and  certain  industrials  which 
have  a  fixed  charge  for  services  or  commodities,  suffer  under 
unequal  competition — since  their  rates  remain  the  same  and 
their  cost  of  operation  remains  the  same.  The  only  way  in  which 
corporations  may  offset  this  disadvantage  is  by  a  more  than 
relatively  permanent  increase  in  gross  returns. 

Banks,  under  this  same  stimulus,  expand  their  credit  in 
order  to  take  advantage  of  the  high  rates  offered  on  commercial 
paper,  but  the  continued  pyramiding  by  weaker  institutions 
soon  forces  the  conservative  banking  institutions  to  reduce  loans 
in  order  to  build  up  their  reserves.  This  action  accelerates  the 
cost  of  credit,  with  the  result  that  the  creditors  who  have  taken 
large  speculative  risks  are  forced  to  offer  unwarranted  rates 
with  the  hope  that  they  may  save  themselves.  But  the  pressure 


MARKET  INFLUENCES  191 

is  too  great  and  the  weak  fail,  and  with  them  the  whole  busi- 
ness structure  is  involved.  Banks  call  their  loans,  depositors 
withdraw  their  funds,  unprotected  holdings  are  liquidated,  and 
security  holders  sacrifice  their  securities  to  save  what  they  can. 
Bad  crops  may  accelerate  the  crisis,  and  thus  hasten  a  panic,  but 
of  themselves  they  will  not  create  a  panic.  Neither  will  good 
crops,  on  the  other  hand,  stop  a  panic.  They  may  temporarily 
check,  but  they  cannot  stop  it. 

Fluctuations  in  Individual  Security  Prices.1 — The  increased 
net  yield,  which  is  the  reward  of  the  investor  who  has  taken 
advantage  of  fluctuating  markets  in  the  last  quarter  of  a  cen- 
tury, has  already  been  fully  emphasized.  These  fluctuations 
can  all  be  traced  to  a  corresponding  change  in  the  money  and 
credit  market.  But  because  of  this  sensitiveness  of  security 
prices  to  credit  and  the  possible  counter  influence  of  other 
market  factors,  correspondingly  greater  care  must  be  used 
before  drawing  conclusions. 

Long  time  movements  of  the  various  classes  of  securities 
tend  to  move  in  fairly  close  accord,  though  the  changes  in  these 
permanent  movements  will  occur  in  the  order  of  the  character 
of  the  security  and  the  breadth  of  its  market.2  Variations  are 


aThe  most  dependable  quotations  and  lists  of  current  security  prices 
covering  the  longest  period  are  those  of  the  Commercial  and  Financial 
Chronicle,  the  Financial  Review,  and  Wall  Street  Journal.  There  are 
a  very  considerable  number  of  financial  publications  which  now  give 
reliable  quotations,  but  they  do  not  cover  as  long  a  period  as  the  above- 
mentioned  journals. 

'Wesley  C.  Mitchell,  The  Prices  of  American  Stocks,  1890  to  1910, 
Journal  of  Political  Economy,  vol.  xviii,  No.  7,  July,  1910,  pp.  513-525. 

American  Security  Prices  and  Interest  Rates,  Ibid,  vol.  xxiv,  No.  2, 
Feb.,  1916,  pp.  126-157. 

Thos.  Gibson,  Influences  Affecting  Security  Prices  and  Values, 
Annals  of  American  Academy  of  Political  and  Social  Science,  vol.  xxxv, 
No.  3,  1910,  pp.  145-154. 

See  also  the  same  author's  Cycles  of  Speculation  (1907). 

Hartley  Withers,  Stock  and  Shares  (1911),  pp.  283-312. 

G.  C.  Selden,  Trade  Cycles  and  the  Effort  to  Anticipate,  Quarterly 
Journal  of  Economics,  vol.  xvi,  pp.  293-310. 

Lawrence  Chamberlain's,  Principles  of  Bond  Investment  (1911), 
pp.  492-512. 

Frederick  D.  Bond,  Stock  Prices:  Factors  in  Their  Rise  and  Fall 
(Moody's  Magazine  Book  Dept,  1911). 

J.  P.  Norton,  Statistical  Studies  in  the  New  York  Money  Market 
(1902). 

Harvard  Bureau  of  Statistics,  Current  Monthly  Publications  on  Mar- 
ket Indices,  Annual  since  January  1,  1919. 


192  INVESTMENT  ANALYSIS 

also  likely  to  be  more  marked  between  bonds  and  stocks  than 
between  industrial  and  railroad  stocks.  Influences  causing 
deviations  from  the  normal  trend  are  the  most  difficult  to  dis- 
cover. They  become  so  great  at  times  that  temporarily  they 
become  a  major  influence,  but  they  are  always  sporadic  and 
when  their  force  is  spent,  the  normal  influences  continue  to 
operate.  For  illustration,  the  over-capitalization  of  industrials 
in  the  great  organization  period  from  1896  to  1901  checked  indus- 
trial security  prices  from  rising  to  the  same  relative  degree  as 
railroad  securities.  The  exact  opposite  was  true  during  1905 
and  1906.  Although  railroad  stocks  did  rise  very  markedly, 
their  rise  was  not  so  great  relatively  as  the  increase  in  industrial 
stock  prices,  for  during  this  period  the  anti-railroad  legislation 
checked  the  advance  that  would  normally  have  occurred  in 
railroad  security  prices. 

General  bond  prices,  as  already  pointed  out,  are  normally 
more  susceptible,  than  other  securities,  to  changes  in  interest 
rates.  After  a  liquidated  market,  the  banks  are  timid  and  buy 
heavily  in  bonds  of  the  first  rank,  but  as  the  market  gradually 
gains  strength,  the  banks  turn  to  cheaper  bonds.  The  demand 
for  money  under  the  continued  upward  swing  of  the  market  and 
the  attendant  business  expansion,  then  increases,  and  the  banks 
begin  to  liquidate  their  bonds  to  secure  funds  for  the  increased 
demand  for  loans  on  stocks  at  higher  rates.  Bond  prices,  after 
this  point,  suffer  a  reaction.  If  the  decline  of  bond  prices  con- 
tinues for  any  length  of  time,  even  with  a  persistent  upward 
trend  of  industrial  and  railroad  stock  prices,  it  signifies  an 
over-expansion  of  credit,  which  results  in  a  forced  liquidation. 

Eailroad  securities,  also,  suffer  a  greater  decline  relatively 
than  industrial  securities,  during  a  period  of  higher  interest 
rates.  This  is  true,  whether  the  increase  in  rates  arises  from  an 
overexpansion  of  credit  or  from  the  general  upward  trend  of 
the  price  level.  In  an  over-expanded  credit  market,  with  the 
large  borrowings  that  a  railroad  is  often  forced  to  make,  its 
securities  usually  suffer  a  considerable  decline.  Industrials  are, 
on  the  average,  not  such  large  long  time  borrowers  and,  over 
long  periods,  can  more  easily  readjust  their  cost  to  their  rate 
of  returns.  Eailroads,  as  well  as  all  public  utilities,  will  also 


MAKKET  INFLUENCES  193 

suffer  the  most  with  a  decline  of  gross  earnings.  Fixed  charges 
for  these  latter  corporations  are  relatively  larger  than  with 
industrials,  and  as  a  consequence  operating  costs  increase  at  a 
faster  rate  than  the  rate  of  decline  in  gross  earnings. 

The  reports  of  the  fabulous  war  fortunes,  and  the  glamour 
which  has  attended  the  " skyrocketing"  of  a  few  of  the  "war 
brides,"  require  a  word.  Though  this  is  primarily  a  problem 
of  speculative  securities,  this  movement  did  have  a  decided 
"market-wise"  effect  on  investment  securities.  Like  all  great 
speculative  booms,  it  moved  beyond  the  limit  of  its  support  and 
suffered  a  collapse.  The  phenomenal  rise  occurred  in  the  war 
industrials  and  ordinance  stocks  and  did  not  apply  to  the  whole 
market.  Public  utility  stocks,  especially  railroad  stocks,  did 
profit  during  the  first  eighteen  months  of  the  War,  but  they  soon 
lost  this  advantage  because  of  the  increased  costs  of  material 
and  labor.  Excluding  the  so-called  war  stocks,  the  rise  of  prices 
is  not  out  of  proportion,  as  Mr.  Huebner  states,  with  other  bull 
markets.1 

Rising  and  Falling  Prices  and  Their  Relation  to  Investment 
Yields. — There  are  two  risks  connected  with  securities,  as  Pro- 
fessor Fisher  so  clearly  has  pointed  out  in  his  "Purchasing 
Power  of  Money. ' ' 2  The  first,  peculiar  to  the  internal  weakness 
or  strength  of  the  individual  corporation,  furnishes  the  main 
theme  of  this  text.  The  second  is  the  effect  which  the  chang- 
ing value  of  the  standard  money  may  have  on  the  value  of  the 
security.  The  influence  of  the  latter  is  the  more  subtle  and 
difficult  to  determine.  To  the  casual  observer,  this  influence  has 
seemed  so  insignificant  that  it  has  too  often  been  lightly  con- 
sidered. 

The  phenomena  of  rising  prices  since  1896,  and  especially 
the  radical  rise  for  the  war  period  and  after,  have  been  so 
widely  discussed  that  the  various  causes  advanced  for  this  rise 
are  now  well  known,  though  difference  of  opinion  still  exists  as 
to  their  relative  importance.  However,  the  pressure,  on  the 


1S.  S.  Huebner,  the  American  Security  Market  During  the  War,  The 
Annals  of  the  American  Academy  of  Political  and  Social  Science,  vol. 
Ixvii  (Nov.,  1916),  p.  104. 

"Irving  Fisher,  Purchasing  Power  of  Money  (1913). 


194  INVESTMENT  ANALYSIS 

investor,  in  the  decrease  in  the  purchasing  power  of  money  is 
making  itself  considerably  felt  at  the  time  this  book  is  being 
written,  by  his  demand  for  higher  bond  rates.  Bonds  of  the 
strongest  railroad  systems  which  in  the  early  nineties  were  sell- 
ing on  a  2l/2  to  a  3  per  cent  basis,  are  now  selling  on  a  net  yield 
of  from  5  to  6  per  cent.  British  consols,  which  have  no  artificial 
market,  as  do  United  States  2s  of  1930,  have  gradually  been 
following  the  same  downward  trend  since  1900.  The  fact  that 
this  price  level  readjustment  has  not  been  peculiar  to  the  United 
States,  but  is  a  world  phenomenon,  is  sufficient  proof  that  it 
should  not  be  overlooked  by  the  investor. 

Where  securities  are  classified  on  the  basis  of  returns,  they 
are  divided  into  two  classes :  those  that  have  a  fixed  return  and 
those  that  have  a  variable  return.  The  first  class  includes  bonds, 
mortgages,  notes,  and  most  preferred  stocks ;  the  second,  partici- 
pating bonds  and  common  stock.  Now,  the  interests  of  the 
holders  of  these  two  general  classes  of  securities  are  diametri- 
cally opposed  either  in  a  general  rise,  or  a  general  lowering  of 
the  prices.  The  bond  holders  of  a  corporation  lose  when  general 
prices  are  rising  and  the  stockholders  gain,  other  things  being 
equal.  When  prices  are  falling,  the  bondholders  gain  and  the 
stockholders  lose. 

An  illustration  will  best  verify  the  latter  statement.  Let  us 
assume  that  a  corporation  is  -capitalized  at  $1,000,000  and  that 
50%  of  this  capitalization  is  in  the  form  of  5%  bonds.  Fur- 
ther, the  gross  sales  are  $500,000  and  all  costs  are  80%  of  gross 
sales,  exclusive  of  interest  charges.  If  the  same  interest  charges 
should  still  exist  because  of  a  long  term  bond  outstanding,  what 
would  common  stock  be  earning  if  the  general  price  of  com- 
modities advanced  40%  ?  In  the  latter  problem  all  costs  on  a 
40%  increase  would  rise  from  $400,000  to  $560,000,  and  gross 
sales  from  $500,000  to  $700,000.  Deducting  the  constant  inter- 
est charge  of  $25,000,  we  would  have  net  profits  of  $75,000  and 
$115,000  respectively.  With  this  increase  of  40%  in  the  price 
of  commodities,  then,  the  rate  of  return  to  the  stockholder 
increases  from  15  per  cent  to  23  per  cent,  or  expressed  in  pur- 
chasing power,  the  income  yield  of  the  capital  stock  has 
increased  53  per  cent  as  against  a  40  per  cent  increase  on  gen- 


MARKET  INFLUENCES  195 

eral  commodities.  The  annual  income  of  the  bondholders,  on 
tne  other  hand,  has  decreased  in  purchasing  power  from  $25,000 
to  $15,000  at  the  end  of  the  period,  and  the  principal  has 
decreased  in  purchasing  power  from  $500,000  to  $300,000. 
Assuming  that  this  advance  was  evenly  distributed  at  the  rate 
of  2.5  per  cent  per  annum,  it  would  give  a  return  of  a  little 
more  than  y%  of  1  per  cent  per  annum  for  the  period  at  an 
equal  rate.  Assuming  the  process  to  be  reversed,  the  bond- 
holder would  have  a  corresponding  gain  and  the  stockholder  a 
loss. 

What  applies  to  bonds  with  their  fixed  rate  of  return,  also 
applies  to  all  other  long  tenure  securities  with  a  fixed  rate  of 
return.  This  is  true  of  preferred  stocks  which  have  fixed  divi- 
dends. Where  the  dividend  rate  is  flexible,  as  on  common  stock, 
this  handicap  could  be  overcome  by  an  increase  of  the  dividend 
rate,  provided  earnings  warranted.  The  solution  of  this  prob- 
lem for  public  utility  companies  is  not  so  simple,  however,  for 
the  regulations  imposed  by  state  commissions  fix  the  rates  that 
can  be  charged  by  the  company,  thus  indirectly  limiting  the 
dividend  rate.  If,  in  addition  to  this  fixed  regulation,  costs  of 
operating  are  mounting  very  rapidly,  as  from  1914  to  1920  the 
public  utility  is  caught  between  two  millstones.  While  this 
situation  was  slowly  developing  prior  to  1914  because  of  chang- 
ing prices,  peculiar  and  temporary  conditions  which  existed 
with  public  utilities  offset  the  effect  of  increasing  costs.  This 
offsetting  cause  existed  in  the  faster  rate  of  expansion  in  public 
utility  companies  (from  1895  to  1914)  as  compared  to  the  slower 
increase  in  costs.  At  the  same  time  new  economies  were  made 
possible  through  the  operation  of  larger  organization  made  nec- 
essary to  meet  this  increased  demand.  With  the  increased  cost 
of  labor  and  material  immediately  following  the  outbreak  of 
the  War,  this  former  advantage  was  not  only  lost,  but  public 
utilities  had  difficulty  in  meeting  their  fixed  charges. 

If  the  credit  of  the  corporation  is  to  be  maintained  under 
increasing  prices,  not  only  must  a  sufficient  increase  in  rates 
be  allowed  to  permit  the  corporation  to  offset  the  immediate 
losses,  but  a  sufficient  increase  must  be  allowed  to  return  the 
higher  net  yield  which  will  ultimately  be  demanded  by  the 


196  INVESTMENT  ANALYSIS 

investor.  With  public  utilities  which  are  artificially  limited  to 
what  they  may  receive  for  their  services,  the  pressure  has  been 
the  most  severe.  And  the  situation  is  only  intensified  when 
additions,  betterments,  and  extensions  are  needed,  which  will 
cost  more  than  the  original  installations  of  the  plant.  To  make 
it  possible  for  these  utilities  to  compete  with  industrials  which 
can  change  their  prices,  the  public  utility  commissions  of  the 
country  must  disregard  the  idea  of  fixed  rates  and  adopt  a 
policy  which  will  adequately  meet  these  changing  needs. 
Where  earnings  are  to  be  regulated,  the  assurance  of  a  fair 
return  on  capital  must  be  made  to  persuade  investors  to  provide 
capital. 

Where  a  corporation  owns  outside  corporations  which  con- 
duct business  foreign  to  its  own,  the  advantage  in  the  increas- 
ing value  of  these  properties  will  generally  have  a  greater  effect 
on  the  value  of  its  stock.  So  many  errors  have  been  made  in 
the  comparison  of  security  averages  through  neglecting  to  dis- 
tinguish between  the  increase  due  to  this  latter  influence,  and 
the  increase  of  value  due  wholly  to  the  increase  of  the  general 
price  level,  that  one  making  a  comparison  of  stock  averages 
should  be  very  cautious  not  to  confuse  them. 

Lastly,  as  already  intimated,  the  rate  at  which  bonds  may 
be  issued  at  one  date  as  compared  to  another,  is  determined  by 
the  existing  rate  of  interest  for  each  particular  risk.1  Now,  if 
the  value  of  the  money  standard  changes — a  change  which 
means  rising  or  falling  prices — a  corresponding  change  in  the 
interest  rate  should  take  place  if  equalization  between  creditor 
and  debtor  is  to  be  secured.  But,  even  where  the  possibility 
of  change  of  value  resulting  from  a  rising  or  falling  price  is 
known  to  exist,  it  is  difficult  to  know  how  long  and  to  what 
degree  of  intensity  the  appreciation  or  depreciation  will  extend. 
If  the  appreciation  or  depreciation  of  the  money  standard  could 
be  accurately  foreseen,  a  similar  change  would  be  made  in  the 
rate  of  interest.  For  illustration,  if  the  present  purchaser  of 
a  bond  knew  that  a  bond  issued  on  a  5  per  cent  basis  would, 
through  a  change  in  the  value  of  the  standard,  be  reduced  in 


Irving  Fisher,  The  Rate  of  Interest  (1907),  pp.  77-86. 


MARKET  INFLUENCES  197 

purchasing  power  to  a  4  per  cent  yield,  he  would  refuse  to  pur- 
chase it  at  that  rate  and  demand  a  price  that  would  yield  5 
per  cent.  That  is,  this  knowledge  would  cause  the  investor  to 
demand  a  rate  that  would  closely  correspond  to  these  changes, 
and  this  demand  would  automatically  force  the  issuing  cor- 
poration to  conform  to  the  change. 


CHAPTER  XII 
REGULATION  OF  THE  ISSUANCE  OF  SECURITIES 

Massachusetts  and  Texas  enforced  radical  regulation  of 
securities,  for  a  number  of  years,  without  even  a  modified 
acceptance  of  their  legislation  by  other  states.  It  was  not  until 
New  York  and  Wisconsin  established  their  public  utility  com- 
missions that  the  present  day  regulation  received  complete 
political  sanction.  In  the  initiation  of  similar  legislation  which 
quickly  followed  in  a  number  of  states,  the  commissions 
were  given  direct  control  over  capitalization  and  security 
issues.  This  power  was  later  included  in  the  amendments  to 
other  statutes  that  had  not  granted  it  at  the  start.  Simultane- 
ously with  this  later  extension  of  the  authority  of  public  utility 
commissions  over  security  issues,  there  have  developed  the 
so-called  "Blue  Sky  Laws"  regulating  the  distribution  of  all 
corporate  securities.1  If  the  signs  of  the  time  are  correctly 
read,  regulation  in  some  form  will  continue.  While  emphasis 
has  been  especially  placed  upon  charges  for  service,  future  regu- 
lation will,  for  some  time  at  least,  give  increasing  importance 
to  capitalization  and  the  security  issues  representing  this  capi- 
talization. With  the  broadening  of  these  powers  we  also  have 
the  more  need  of  carefully  directing  the  development  of  future 
regulation. 

The  ideal  aim  of  state  regulation  of  securities  should  be 
the  creation  of  a  stable  and  sound  market  and  the  encourage- 
ment of  the  investment  of  capital.  Protection  to  the  investor 


laws  regulating  the  investments  of  insurance  companies,  build- 
ing and  loan  associations,  savings  banks,  trustees,  etc..  are  not  included 
in  this  discussion,  as  these  investments  are  regulated  by  separate  and 
distinct  laws  of  their  own.  To  the  student  specializing  in  finance,  a  study 
of  these  laws  is,  however,  of  great  value. 

Regulation  of  Public  Utilities  and  the  relation  of  regulation  to  secu- 
rities is  also  treated  in  chapter  xiv.  In  this  chapter  is  also  considered 
the  present  Federal  Law  regulating  railroads.  See  also  chapter  xix. 

198 


REGULATION  OF  SECURITIES  199 

is  an  incident  which  grows  out  of  this  condition.  To  the  com- 
pany, it  further  means  adequate  funds,  at  lower  rates  and  on 
easier  terms,  for  the  development  and  safe  conduct  of  the  busi- 
ness. Most  of  the  legislation  affecting  security  issues  has 
largely  developed  as  an  incident  to  the  regulation  of  services 
and  rates.  Consequently,  principles  which  should  directly  gov- 
ern security  issues  have  been  frequently  confused  with  those 
relating  to  rates  and  services,  whereas  the  two  classes  should  be 
kept  distinct.  This  legislation  is  also  too  recent  in  its  origin, 
not  to  have  a  great  many  defects.  Radical  changes  will  still  con- 
tinue, as  no  precedents  exist,  and  there  will  be  many  failures. 

It  should  also  be  incidentally  emphasized  that  regulation  is 
discussed  here  in  relation  to  investment,  and  not  speculative 
interests. 

As  capital  stock  represents  ownership,  the  greater  risk,  regu- 
lations have  a  far  more  important  direct  bearing  upon  the 
issues  of  capital  stock  than  bonds.  As  the  credit  of  a  corpora- 
tion, however,  is  directly  affected  by  its  total  capitalization,  a 
consideration  of  regulation  is  as  important  to  prospective 
buyers  of  bonds  as  to  buyers  of  stocks.  Where  regulation  of 
bond  issuances  exists,  the  amount  of  the  bonds  issued  is  usually 
fixed  at  a  given  ratio  to  the  assets  or  the  capital  stock  of  the 
corporation.  Even  where  the  statute  does  not  indicate  a  ratio 
between  the  amount  of  the  bonds  issued  and  the  value  of  the 
property,  the  majority  of  the  commissions  have  fixed  upon 
some  such  standard.  The  danger,  of  course,  lies  in  too  rigid 
an  adoption  of  "thumb  rule"  ratios.  The  need  of  elasticity  in 
the  application  of  ratios  is  now  realized  by  most  commissions, 
so  that  the  evils  arising  out  of  the  early  narrow  application, 
whether  applied  to  bonds  or  any  other  phase  of  capitalization, 
are  less  frequent.  The  more  effectively,  however,  standardiza- 
tion can  be  accomplished,  the  more  accurately  may  the  risk  be 
eliminated.  Earnings  of  sufficient  amount  must  be  provided  to 
allow  the  company  to  secure  all  reasonable  requirements  for  its 
own  maintenance,  to  give  a  reasonable  service  and  to  yield  its 
owners  a  just  return.  If  this  is  accomplished  the  credit  of  the 
company  is  enhanced  and  4he  bond  becomes  a  more  stable 
investment. 


200  INVESTMENT  ANALYSIS 

The  three  forms  of  control  of  security  issues  in  the  United 
States  are:  (1)  by  publicity;  (2)  by  an  authorized  government 
agent  or  agents  (either  in  the  form  of  a  special  commission, 
or  attached  to  some  existing  executive  board) ;  (3)  by  the  certifi- 
cation by  state  officials  of  the  validity  of  the  issues  made  by  the 
state's  minor  civil  divisions.  The  so-called  methods  of  public- 
ity, the  first  of  the  methods  of  regulation,  used  in  this  country, 
are  all  of  a  semi-publicity  character.  The  "Blue  Sky  Laws," 
though  based  upon  publicity,  represent  only  a  partial  accept- 
ance of  the  English  idea  of  what  constitutes  publicity.  While 
the  license  required  of  dealers  in  securities  is  itself  regulatory, 
it  is  only  a  means  to  an  end  of  security  publicity.  The  Inter- 
state Commerce  Commission  reports  required  of  railroads,  and 
several  of  the  state  utility  commission  statutes  are  only  modifi- 
cations of  the  publicity  principles,  and  strict  publicity 
through  state  control  cannot  be  said  to  exist  in  the  United 
States,  though  a  great  many  corporations  practice  it  through 
their  own  volition  as  a  matter  of  policy. 

The  development,  under  the  second  type  of  public  regula- 
tion, has  made  an  almost  arbitrary  distinction  between  the  busi- 
ness which  is  or  tends  to  be  monopolistic  and  that  which  is  com- 
petitive. The  regulation  of  the  former  applies  to  railroads, 
street  railways,  gas  companies,  etc.,  and  has  become  very  con- 
siderable and  is  increasing.  Where  the  risk  is  greater,  as  in 
the  industrials,  more  limited  regulation  exists.  As  long  as  the 
risks  are  to  continue,  individual  initiative  must  be  left  unre- 
stricted to  the  extent  of  this  risk,  in  order  to  stimulate  new 
enterprise  and  encourage  the  continuation  of  old  organizations. 
On  the  other  hand,  where  these  enterprises  become  monopo- 
listic, they  will  continue  to  come  under  the  jurisdiction  of  the 
law. 

The  third  type  of  regulation,  the  certification1  of  the  issues 
of  the  minor  civil  divisions  by  a  state  official,  might  be  called  a 


Certification  as  used  here  must  not  be  confused  with  the  certifica- 
tion made  by  a  trustee  for  a  corporation.  A  corporation's  certification 
does  not  carry  with  it  a  surety  of  payment  beyond  its  ability  to  pay. 
Thomas  Mulvey  has  written  an  interesting  summary  of  this  aspect  of 
certification  in  the  American  Economic  Review,  vol.  iv,  pp.  58S-G01  (Sep- 
tember, 1914). 


REGULATION  OF  SECURITIES  201 

guarantee  of  validity,  rather  than  a  form  of  regulation  by  the 
state.  It  is  a  responsibility  assumed  by  a  few  states  which 
could  be  copied  with  advantage  by  all  of  the  commonwealths 
of  the  nation. 

A  study  of  indirect  control  and  regulation  of  all  securities 
by  the  state,  though  not  under  discussion  here,  would  also  be 
made  with  profit.  For  example,  while  the  restriction  of  debt 
limitation  in  no  way  effects  validity,  as  long  as  the  statute  is 
obeyed,  it  does  attempt  to  maintain  an  ample  margin  of  secu- 
rity behind  the  bond.  To  the  same  extent  can  all  statutes  effect- 
ing security  issues  be  considered,  partially  at  least,  regulatory. 
"We  shall  apply  ourselves,  however,  strictly  to  what  would  be 
called  direct  regulation  in  certification,  other  considerations 
being  left  for  subsequent  treatment.  Likewise,  all  the  statutes 
regulating  the  organization  and  control  of  corporations  are 
means  which  directly  or  indirectly  give  more  or  less  protection 
to  the  investor.  Regulation  in  its  broader  aspects  also  includes 
a  study  of  the  Sherman  Act  and  Clayton  Bill,  etc.1  The  distinc- 
tion is  again  drawn  between  what  is  direct  control  of  a  security 
issue  and  that  which  effects  the  safety  of  the  corporation,  i.  e., 
the  internal  strength  of  the  corporation  back  of  the  security. 
This  latter  is  the  problem  of  the  text  matter  of  parts  two  and 
three  of  this  book. 

The  direct  regulation  of  security  issues  includes  two  distinct 
problems:  (1)  the  treatment  of  issues  already  authorized  or  out- 
standing and  their  relation  to  property  values,  and  (2)  the 
regulation  of  new  issues  and  their  relation  to  property  values 
and  security  issues  already  outstanding.  In  the  first  problem, 
the  widely  accepted  idea  of  a  relationship  between  capitali- 
zation and  property  values  necessitates  a  recognition  of  valua- 
tion. This  gives  rise  to  the  whole  and  still  much  disputed  prob- 
lem of  how  such  a  valuation  should  be  made.'  The  necessity 


*See  Discussion  of  Topic  on  Federal  Regulation  in  this  chapter. 

The  several  methods  of  valuation  which  aim  at  a  "fair  value"  are 
laid  down  by  the  Supreme  Court  in  its  early  leading  case  of  Smyth  v. 
Ames  (169  TJ.  S.  466).  The  court  has,  however,  failed  to  formulate  any 
definite  principles  either  in  this  or  later  cases  as  to  how  fair  value  shall 
be  determined,  except  to  indicate  that  certain  factors  must  be  given 
consideration.  With  the  limitation  of  accurate  and  incomplete  data, 
and  the  newness  of  the  problem,  the  courts  have  done  well  in  not  for- 


202  INVESTMENT  ANALYSIS 

of  physical  valuation  in  particular  cases  is  beyond  dispute.  But 
it  is  extremely  doubtful  whether  the  wholesale  valuation  of  all 
public  utilities  is  warranted  both,  because  of  the  expenses  in- 
volved and  the  results  attained. 

After  a  physical  valuation  is  made,  serious  injustice,  apart 
from  legal  difficulties,  may  result  in  scaling  down  the  securities 
if  over- valuation  exists;  and,  secondly,  new  issues  needed  for 
improvement  may  be  debarred.  The  application  of  any  valua- 
tion made  must  qualify  itself  to  the  extent  of  maintaining  the 
credit  of  the  corporation.  This  is  imperative  to  the  interest  not 
only  of  the  investor,  but  also  of  the  public.  The  indirect  loss 
arising  out  of  a  valuation  which  gives  no  recognition  to  the 
other  factors  is  often  even  greater  than  the  direct  effects  of  pure 
physical  valuation.  The  Supreme  Court,  in  all  of  the  leading 
cases  that  have  come  before  it,  has  always  given  large  impor- 
tance to  this,  in  its  emphasis  of  all  the  factors  which  must  be 
used  in  the  determination  of  fair  value.  "Such  a  readjust- 
ment," states  the  Hadley  Federal  Eailroad  Securities  Commis- 
sion, "would  become  archaic  almost  from  the  outset,  because  an 
adjustment  of  securities  based  upon  the  values  of  today  might 
be  wholly  erroneous  tomorrow." 

Publicity. — The  function  of  government  regulation  by  pub- 


uiulating  a  precedent  from  which  they  might  be  compelled  to  retract  in 
whole  or  in  part. 

Out  of  the  statutes  and  court  and  commission  decisions  have  developed 
the  more  frequently  used  methods  of  valuation  based  upon  (1)  Original 
cost;  (2)  Reproduction  cost;  (3)  Present  cost — i.e.,  actual  replacement 
cost  less  depreciation;  (4)  Market  value,  based  upon  earnings.  A  com- 
plete discussion  of  valuation  can  be  had  in  such  texts  as :  Homer  Bews 
Vanderblue's  Railroad  Valuation.  This  little  volume  is  probably  the 
most  comprehensive  treatment  which  has  yet  appeared  on  railroad  valu- 
ation. H.  H.  Hartman,  on  Fair  Values,  is  closely  patterned  after  Mr. 
Vanderblue's  treatise;  R.  H.  Whitten,  Valuation  of  Public  Service  Cor- 
porations, is  principally  a  source  book  upon  disputed  points  in  valua- 
tion. The  Transactions  and  Proceedings  of  the  American  Society  of 
Civil  Engineers  contain  many  valuable  discussions  from  the  engineer's 
point  of  view.  Other  useful  standard  books  are :  Henry  Floy.  Valuation 
of  Public  Utility  Property;  Horatio  A.  Foster.  Engineering  Valuation  of 
Public  Utilities;  Hammond  V.  Hayes.  Public  Utilities,  Their  Cost  New 
and  Depreciation;  Harry  Barker,  Public  Utility  Rates.  From  the 
extended  bibliographies  contained  in  some  of  the  books  numerous  other 
sources  will  be  found. 

aHadley  Federal  Railroad  Securities  Commission,  Letter  of  Trans- 
missal  to  President  Taft,  November,  1911,  p.  18. 


202 

licity  is  to  furnish  the  investor  with  sufficient  and  accurate 
information  to  enable  him  to  exercise  his  own  judgment — the 
risk  of  the  investment  to  be  borne  by  the  investor.  The 
defenders  of  the  publicity  program  maintain  that  the  corporate 
management  will  be  forced  by  popular  opinion  to  adopt  equit- 
able policies  toward  customer  and  security  holder.  Self-regula- 
tion of  this  kind  has  the  decided  advantage  of  simplicity,  and 
is  inexpensive  to  the  state.  It  also  eliminates  the  necessity  of  a 
large  number  of  statutes.  Where  legislative  regulation  exists, 
there  is  a  continual  need  of  amendments  and  3specially  of  the 
rulings  of  courts  and  commissions,  which  not  infrequently  lead 
to  conflicting  regulations.  Amendments  themselves  are  often  a 
forced  acknowledgment  of  the  error  of  a  statute.1 

There  is  a  very  much  mistaken  notion,  in  the  minds  of  many 
people,  as  to  the  extent  to  which  the  principles  of  publicity  have 
been  adopted  in  the  United  States.  The  unrestricted  policy 
allowed  industrial  corporations  and  the  atmospheric  character 
of  their  capitalization  which  followed  the  great  consolidation 
period  after  1898  are  always  cited  as  conclusive  evidence  of  the 
evils  of  non-regulation  and  the  desirability  of  publicity.  One 
of  the  most  notable  features  of  these  ill-fated  industrials,  which 
still  bear  the  burden  of  an  ill-advised  financial  program,  was 
the  lack  of  information  given  the  public  who  were  invited  to 
participate.  It  is  interesting  reading  to  pursue  the  old  pros- 
pectuses of  these  industrials  and  to  see  how  much  could  be  said 
about  so  few  facts.  Needless  to  say,  this  is  not  publicity. 

Publicity  in  the  United  States  has  not  been  required  until 
recently,  and  has  not  been  given  except  where  the  corporation 
has  been  willing  to  give  it.  Circulars  of  speculative  security 
offerings  have  continually  been  issued  which  were  entirely  mis- 
leading, not  because  of  errors  in  statement,  but  because  of  the 


'Germany's  law  of  1896,  regulating  stock  exchange  transactions,  is 
probably  one  of  the  most  striking  examples  in  modern  times  of  cht 
futile  attempts  to  disregard  the  fundamentals  of  economics  in  taw.  This 
statute  is  deserving  of  careful  study  by  those  who  are  prone  co  adopt 
regulation  for  regulation's  sake  without  regard  to  its  final  economic 
consequences.  For  an  excellent  discussion  of  the  effect  of  this  law,  see 
article  by  Ernest  Shuster  in  Economic  Journal,  England,  vol.  x,  pp.  1-19  • 
also  reprinted  in  Ripley's  Trusfs,  Pools  and  Corporations  (1st  ed.),  op, 
393-413. 


204  INVESTMENT  ANALYSIS 

omission  of  facts.  Statements  of  book  values,  high  and  low 
price,  surplus  earnings  and  anticipated  earnings,  often  the  only 
data  given,  may  be  entirely  misleading  when  viewed  as  isolated 
facts. 

Some  of  the  statutes  creating  state  commissions  and  purport- 
ing to  force  corporations  to  maintain  publicity  policies  are  only 
so  in  name,  though  marked  advancement  has  been  made  in 
other  states.  The  English  method  of  controlling  publicity  is 
much  superior  to  the  American,  though  the  United  States  na- 
tional government  has  demonstrated  its  ability  in  the  supervi- 
sion and  publicity  of  the  national  banking  system.  In  England 
the  government  must  be  given  a  statement  of  the  capital  needs 
and  the  proposed  case  of  the  new  securities,  which  must  be 
certified  to  by  public  auditors.  All  statements  submitted  to 
shareholders  must  likewise  be  certified,  and  the  auditors  are 
held  accountable  for  their  certification.  The  result  is  that  the 
English  investor  has  a  much  more  complete  set  of  facts  con- 
cerning all  underwritings  than  is  available  to  the  American 
investor,  except  where  voluntarily  given  by  a  few  corporations. 

The  Hadley  Railroad  Securities  Commission,  which  strongly 
advocated  publicity,  stated:  "Your  Commission  recommends  the 
adoption  of  provisions  (referring  to  railroads)  regarding  pub- 
licity which  will  show  the  actual  facts  regarding  stock  and  bond 
issues  in  the  several  states  and  the  considerations  received  there- 
for. ' '  Because  of  the  character  of  the  Commission,  the  decided 
position  taken  by  it  in  its  advocacy  for  publicity  attracted  wide 
attention  and  gave  considerable  stimulus  to  state  programs  for 
"Blue-Sky  Law"  legislation  referred  to  later.  The  intimation 
of  any  guarantee  by  the  government,  this  Federal  Commission 
considered  dangerous  procedure,  unless  the  government  is  will- 
ing to  give  the  guarantee  of  a  return  on  the  investments.  In 
speaking  of  standardization,  the  Commission  further  states : 

"  .  .  .  The  government  cannot  protect  the  investors  against 
the  consequences  of  their  unwisdom  in  buying  unprofitable 
bonds,  any  more  than  it  can  protect  the  consumers  against  the 
consequences  of  their  unwisdom  in  eating  indigestible  food.  Un- 


JHadley,  Federal  Railroad  Securities  Commission,  Letter  of  Trans- 
missal  to  President  Taft  (Nov.,  1911),  p.  15. 


REGULATION  OF  SECURITIES  205 

less  we  are  prepared  to  have  government  guarantees  of  interest 
on  railroad  investment — a  most  questionable  proposal — the  only 
way  in  which  we  can  standardize  railroad  mortgages  is  the  one 
which  we  use  with  savings  bank  mortgages.  We  can  insist  on 
double  security.  We  can  say  that  at  least  half  the  capital  of  a 
railroad  must  be  subscribed  by  stockholders  and  that  not  more 
than  half  may  be  raised  by  borrowing — a  difficult  requirement 
under  existing  conditions.  Until  we  are  prepared  to  pass  some 
law  of  this  kind,  the  investor  must  depend  upon  his  own  in- 
telligence to  protect  him  from  loss.  The  function  of  the  gov- 
ernment is  to  see  that  correct  information  is  available. ' ' 1 

Quite  apart  from  the  advantages  or  disadvantages  of  regula- 
tion, which  one  might  still  advocate,  the  position  of  the  Hadley 
Federal  Securities  Commission  on  the  danger  of  leading  the 
public  to  believe  that  the  government  will  guarantee  a  rate  of 
return  on  investments  cannot  be  disregarded.  In  a  temporary 
crisis,  like  the  European  war,  when  everything  must  give  way, 
and  rightly,  to  the  war  needs,  such  a  guarantee  may  be  justified 
to  retain  the  stability  of  industry.  Regulation,  if  it  serves  its 
full  purpose,  should  stabilize  and  increase  the  value  of  the  cor- 
poration and  thus  increase  public  confidence  in  the  securities, 
but  it  should  not  guarantee.  Even  if  the  government  should 
control  all  utility  properties,  a  guarantee  to  stockholders  and 
bondholders  would  be  fundamentally  unsound.  If  the  cor- 
poration failed  to  earn  its  return,  the  citizen  would  be  taxed  to 
pay  the  return — a  ' '  taking  from  one  pocket  and  putting  into  an- 
other." And  what  of  the  temptation  to  shift  the  burden  of 
responsibility?  Too  frequently,  municipal  ownership  advocates 
carry  some  vague  notion  of  fixed  returns — not  having  thought 
out  the  evil  consequences  of  guarantees. 

If  regulation  is  to  add  to  itself  the  obligation  of  guaran- 
tee it  must  sooner  or  later  fail.  That  the  state  should  have  the 
authority  to  stop  fraudulent  sales  and  excessive  issues,  no  one 
will  deny,  but  it  should  never  be  made  responsible  for  errors  of 
judgment  or  for  the  unforeseen  developments  that  result  in 
losses,  except  in  the  case  of  wilful  fraud.  Nevertheless,  it  is 
astonishing  how  widespread  a  dependence  is  placed  on  the  Com- 
missioners' approval  of  a  security  issue  as  a  guarantee. 

'Ibid.,  p.  33. 


206  INVESTMENT  ANALYSIS 

The  danger  of  such  a  guarantee,  where  no  control  over  the 
management  is  exercised,  is  apparent.  Former  over-capitaliza- 
tion, difference  in  costs  of  production  at  various  periods,  shift- 
ing of  policies,  changes  in  management,  etc.,  would  make  any 
specific  acceptance  of  such  a  principle  exceedingly  difficult. 
Indirectly  the  commission  can  give  its  assurance  by  refusing 
the  approval  of  an  issue  where  a  satisfactory  return  cannot  be 
made  by  the  corporation  on  the  new  issue.  If  additional  service 
is  demanded  and  the  corporation's  capitalization  and  manage- 
ment are  of  good  standard,  no  alternative  in  equity  to  the  com- 
pany exists,  except  to  allow  both  the  issue  of  securities  and  a 
rate  of  return  that  will  give  a  proper  return  on  the  investment. 

While  a  commission  with  power  to  control  the  issue  of  secur- 
ities cannot  safely  depart  from  this  practice,  its  elasticity  of 
procedure  should  always  permit  a  fair  rate  of  return  upon  a 
fair  capitalization.  No  regulation  should  be  so  inelastic  as  not 
to  permit  of  a  change  in  rate.  The  slowness  with  which  the 
need  of  increased  rates  in  public  utilities  was  recognized  during 
the  European  war,  illustrates  the  rigidity  with  which  we  cling 
to  a  customary  charge  without  any  economic  justification.  An 
earlier  recognition  of  this  condition  would  have  prevented  some 
of  the  difficulties  in  the  later  demand  for  capital.  But  this 
recognition  is  not  a  guarantee;  it  is  only  an  application  of 
equity  where  equity  is  due.  The  underlying  motive  of  the 
decisions,  for  example,  of  the  Massachusetts  Commission  in  the 
recognition  of  this  situation  was  only  a  recognition  of  the  equity 
of  the  demand  and  not  a  guarantee  of  return.1 

Blue  Sky  Laws. — Agitation  for  blue  sky  laws  has  been 
revived  since  the  United  States  Supreme  Court's  decision  up- 
holding the  Blue  Sky  Laws  of  Michigan,  South  Dakota,  and 
Ohio.  Legislation  directly  regulating  the  issue  of  securities  will 
be  sooner  or  later  adopted  by  all  states.  Of  the  different  types 
of  Blue  Sky  Legislation,  the  so-called  Attorney-General  Act 
adopted  by  several  states  has  had  widest  acceptance  and  with 
certain  amendments  to  some  of  its  drastic  features,  furnishes, 
according  to  the  counsel  of  the  Investment  Bankers  Association, 


^lassachusetts,    Public  Service    Commission    Reports    and    Orders 
(1914). 


REGULATION  OF  SECURITIES  207 

"the  best  basis  for  any  possible  uniformity  between  the  states." 
The  same  authority  further  states  of  the  Federal  decision: 
"The  general  principle  that  the  business  of  dealing  in  securi- 
ties may  be  made  the  subject  of  a  discretionary  executive  license 
by  the  state  without  violating  the  Federal  Constitution  is  clearly 
established  by  the  decisions,  as  is  also  the  proposition  that  with- 
out violating  that  Constitution,  the  conduct  of  this  business  may 
be  subject  to  some,  if  not  a  complete  control  by  a  state  exe- 
cutive."1 

Twenty-eight  states,  up  to  date,2  have  adopted  "blue-sky 
law"  legislation  of  some  form,  following  the  lead  of  Kansas, 
which  passed  its  original  act  in  1911.  The  states  which  first 
adopted  blue  sky  legislation  passed  exceedingly  drastic  meas- 
ures. In  the  majority  of  cases,  however,  they  have  since  recog- 
nized the  injustice  of  their  early  statutes,  and  modified  them.3 
The  more  recent  adoption  of  the  New  Hampshire  law  and  the 
defeat  of  drastic  bills  in  other  states,  indicate  a  change  from 
the  earlier  radicalism  and  the  recognition  of  more  equitable 
principles  in  the  control  of  security  issues.  Until  provision  is 
made  for  more  rigid  requirements  for  the  permanent  appoint- 
ment of  qualified  officials  to  take  charge  of  the  administration 
of  these  laws,  regulation  of  securities  must  have  considerable 
limitations. 

Practically  all  of  the  existing  blue  sky  laws  are  framed  on 
the  common  requirement  of  prohibiting  the  sale  of  securities 
within  the  state,  unless  the  organization  or  individual  first  reg- 
isters and  pays  a  registration  fee.  In  addition  to  this,  certain 
information  concerning  the  corporation  must  be  filed.  The  cor- 


llnvestment  Bankers?  Association  Bulletin,  vol.  v  (Feb.  15,  1917), 
p.  67. 

2The  majority  of  the  important  blue  sky  law  acts  up  to  January  1, 
1921,  have  been  printed  in  the  Current  Bulletins  of  the  Investment 
Bankers'  Association,  or  they  can  easily  be  secured  from  the  state  offi- 
cials. They  are  changed  so  frequently  that  it  has  not  been  considered 
advisable  to  give  detailed  citations. 

SA  comprehensive  review  of  security  regulation  is  to  be  found  in  a 
Report  on  Company  Capitalisation  Control  compiled  by  Thomas  Mulvey 
for  the  State  Department  of  Canada. 

The  article  by  Mr.  Robert  R.  Reed  on  "Blue  Sky  Laws"  (in  the 
Annals  of  the  American  Academy  of  Political  and  Social  Science,  vol. 
Ixxxviii  [March.  1920],  pp.  177-187),  should  be  read  by  every  student. 


208  INVESTMENT  ANALYSIS 

poration,  individual,  or  any  other  agency  selling,  advertising, 
or  negotiating  for  the  sale  of  these  securities  is  then  given  an 
annual  license.  Certain  securities,  as  those  listed  on  an  organ- 
ized stock  exchange -and  others  specified,  are  usually  exempted 
from  the  law.1  The  information  required  of  the  corporation 
whose  securities  are  to  be  sold  varies  in  detail  and  is  not  essen- 
tial for  the  purposes  at  hand.  The  state  official  practically 
always  has  the  power  to  make  an  investigation,  if  he  deems  it 
desirable — the  expense  to  be  borne  by  the  applicant.  This  official 
also  has  the  power  of  revoking  the  license  in  case  of  fraud  or 
insolvency.  Investigations  are  supposed  to  proceed  until  the 
official  has  satisfied  himself  that  no  fraud  has  been  perpetrated. 
The  underlying  principle  of  all  of  the  blue  sky  laws  is  modified 
publicity. 

Probably  the  most  important  feature  in  these  "blue-sky- 
law"  bills  is  the  restriction  placed  upon  the  dealer  in  securities 
located  in  one  state  and  selling  securities  through  personal 
solicitation,  advertising,  letters,  or  other  means  in  another  state 
without  official  permission  of  the  latter.  The  purpose  of  these 
laws  is  to  prevent  a  dealer,  when  forbidden  by  one  state,  from 
going  into  a  foreign  state  and  selling  securities  in  defiance  of 
this  restriction.  Like  all  state  laws  regulating  interstate  busi- 
ness, it  creates  a  number  of  unjust  situations,  and  works  a  hard- 
ship upon  the  legitimate  banker  in  his  effort  to  eliminate  fraud- 
ulent "get-rich-quick"  schemes.  The  elimination  of  these 
fraudulent  dealers  and  their  wares  no  one  denies  must  be  accom- 
plished. Is  the  method  provided  by  these  laws,  however,  the 
most  effective  means  by  which  this  can  be  accomplished?  An 
editorial  a  few  years  ago  put  the  problem  tersely:  "Undoubt- 


*Mr.  Reed  states  concerning  these  exemptions :  "Before  offering  a 
particular  security  in  a  'blue  sky'  state  the  issuer  or  dealer  must  deter- 
mine whether  the  law  applies  to  that  security.  Certain  kinds  of  sales, 
such  as  sales  by  the  owner  not  in  the  course  of  repeated  transactions, 
sales  to  a  bank  or  dealer  and  new  stock  issues  to  existing  stockholders 
are  exempt.  Certain  classes  of  securities  are  also  exempt,  including 
governmental  and  municipal  bonds,  approved  public  utility  securities 
and  securities  senior  thereto ;  securities  dealt  in  on  approved  exchanges 
or  regularly  quoted  in  newspapers  for  a  year  and  securities  senior 
thereto ;  also  certain  classes  of  local  securities,  such  as  bank  stocks, 
commercial  paper  and  first  mortgage  bonds  or  real  estate  in  the  state. 
Manifestly  many  sound  and  necessary  investment  offerings  are  not  in- 
cluded in  these  offerings."  (Ibid.,  pp.  181-182.) 


REGULATION  OF  SECURITIES  209 

edly,  the  growth  in  the  volume  of  corporate  securities  and  the 
increase  in  the  number  of  investors,  make  necessary  more  care- 
ful regulation  of  the  marketing  of  such  securities.  The  cor- 
poration laws  should  be  simplified — possibly  a  uniform  state 
law  or  a  Federal  incorporation  act  may  be  essential.  But  the 
attempts  of  each  state  in  its  own  way  to  deal  with  this  problem 
are  by  no  means  devoid  of  harmful  possibilities,  however  praise- 
worthy the  aim  may  be."1 

A  number  of  these  laws  are  so  badly  framed  that  they  will 
never  fulfill  what  has  been  claimed  for  them.  Many  of  them, 
as  the  first  Illinois  law  which  failed  so  ignominiously,  were 
hastily  drawn  up ;  others  were  constructed  by  legislative  bodies 
having  very  little  experience  with  bonds  and  stocks.  If  these 
laws  can  be  built  upon  the  principle  to  protect  and  not  merely 
to  thwart,  they  will  succeed ;  otherwise  they  cannot.  Too  many 
investors  have  assumed  that  ''blue-sky  laws"  guarantee.  They 
do  not — far  from  it.  Certain  conditions  which  insure  greater 
safety  are  supposed  to  be  met,  but  where  a  commission  has 
only  the  power  to  see  that  certain  meager  facts  are  filed,  regula- 
tion can  have  little  consequence.  If  the  facts  are  complete  and 
the  commission  has  the  power  to  go  behind  them,  positive 
results  will  be  accomplished.  The  legitimate  banker  will  always 
submit  complete  facts  to  the  investor.  It  is  the  banker  of  ques- 
tionable repute  who  must  be  forced  to  divulge. 

No  very  complete  or  satisfactory  "blue-sky"  regulation  can, 
however,  be  secured  until  Federal  legislation  can  be  procured. 
Any  one  who  has  given  much  serious  thought  to  this  phase  of 
regulation  has  practically  always  come  to  this  conclusion.  Fur- 
thermore, the  real  problem  lies  deeper.  Effective  control  must 
begin  with  the  original  creation  of  the  corporation.2  This  latter 
control  obviously,  as  Mr.  Eeed  suggests,  cannot  be  effectively 
accomplished  by  state  governments  where  inter-state  interest 
dominates,  while  the  problem  is  a  national  one.  And  as  long 
as  only  one  state  is  concerned  in  its  particular  regulation,  many 
devices  can  be  created  by  the  "fly-by-night"  concern  which 


*Tlie  Bankers  Magazine   (>T.  Y.),  vol.  Ixxxiv    (1912)   p.  636    (edi-. 
torial). 

2Robert  R.  Reed,  Ibid.,  p.  183. 


210  INVESTMENT  ANALYSIS 

desires  to  escape  the  laws  of  this  particular  state  in  securing  its 
capital  funds. 

Certification  of  Civil  Loans. — A  few  states  make  a  certifica- 
tion of  the  validity  of  the  bond  issues  of  the  state  and  its  minor 
civil  divisions.  While  this  cannot  be  called  regulation  in  the 
same  sense  as  issues  of  public  utility  securities  are  now  regu- 
lated, it  is  a  form  of  control  protecting  the  investor.  North 
Dakota,  the  first  state  to  adopt  this  measure,  in  1889,  incorpor- 
ated it  in  its  constitution.  Under  the  North  Dakota  constitu- 
tion no  state  bond  is  valid,  unless  certified  by  the  Auditor  and 
secretary  of  the  state.  In  the  minor  civil  divisions,  the  desig- 
nated financial  officer  of  the  civil  division  must  make  a  similar 
certification,  "stating  that  said  bond  or  evidence  of  debt  is 
issued  pursuant  to  law  and  is  within  the  debt  limit. ' '  As  this 
fixes  the  validity  of  the  issue,  no  claim  against  the  validity  of 
North  Dakota  bonds  can  be  raised.  Similar  clauses  have  been 
incorporated  in  the  constitutions  of  Kansas,2  Nebraska,3  and 
Oklahoma,4  and  in  the  statutes  of  Texas,5  and  West  Virginia;6 
Massachusetts7  has  applied  the  certification  to  the  issuance  of 
town  notes.  The  real  object  of  the  Massachusetts  act  is  to  limit 
the  amount  of  the  floating  debt;  this  subject  is  discussed  subse- 
quently at  greater  length.8  Colorado,9  likewise,  limits  the  appli- 
cation of  the  principle  of  certification  to  refunding  issues,  which 
must  be  registered  with  the  State  Auditor.  New  Jersey  limits 
its  validation  to  school  bond  issues.  The  approval  of  the  valid- 
ity of  these  bonds,  as  with  the  North  Dakota  bonds,  is  made  by 
the  Attorney-General.  The  Acts  of  North  Carolina  limit  the 
period  in  which  suits  can  be  brought  to  thirty  days  after  the 
last  publication  of  the  ordinance.  After  this  no  bond  can  be 


Constitution  of  North  Dakota,  Art.  XII,  Sec.  1ST. 

2See  General  Statutes  of  Kansas  for  1915. 

"Constitution  of  Nebraska.  Art.  XTI.  Sec.  2. 

Constitution  of  Oklahoma  (1907),  Art.  X.  Sec.  29. 

Texas,  Acts  of  1895.  p.  184 ;  Acts  1901,  p.  16 ;  Revised  Statutes  1911, 
Title  XVIII,  Art.  619-625. 

"West  Virginia  Statutes  (1917),  chapter  Ivii. 

'Massachusetts.  Acts  (1910).  p.  616;  Amended  1912,  chaps,  xlv  and 
xlix.  Also  Acts  1915.  chaps.  Ixxxiv  and  cclxxxv. 

"See  chapters  on  Civil  Loans. 

•Colorado,  Revised  Statutes  (1908),  chapter  cxlvii,  Art.  X. 


REGULATION  OF  SECURITIES  211 

contested.1  In  the  New  Jersey  law,  after  which  the  North  Caro- 
lina law  is  patterned,  the  "validity  of  bonds  shall  not  be  ques- 
tioned in  any  suit  commenced  after  the  lapse  of  twenty  days 
from  the  first  publication  of  the  ordinance  or  resolution  author- 
izing them,  unless  in  violation  of  the  referendum  provisions."'' 
Georgia's  law  departs  from  the  practice  of  the  other  states  in 
validating  their  bonds,  by  requiring  a  validation  of  all  county, 
city,  and  other  minor  civil  issues  by  the  Superior  Court,  after 
the  issue  has  been  voted  upon  by  the  civil  division  issuing  the 
bond.* 

State  Regulation  of  Public  Utilit'i/  Issues*  —  The  object  of 
public  utility  regulation,  as  far  as  the  financial  aspect  is  con- 
cerned, is  to  establish  an  equitable  rate  for  the  consumer  and  a 
protection,  together  with  a  fair  rate  of  return  on  the  investment 
to  the  security  holder.  To  secure  the  proper  protection  to  the 
security  holder  both  a  sufficient  equity  in  property  and  adequate 
earnings  must  be  had.  Provided  the  public  utility  corporation 
has  a  sufficient  market  for  its  service,  a  sufficient  rate  is  neces- 
sary to  give  a  safe  and  continuous  return  to  the  security  holder. 
The  adequacy  of  this  rate  to  insure  this  return  to  the  investment 
made  is  considered  in  a  subsequent  chapter.  The  reader  is 
again  reminded  that  the  problem  here  is  one  of  the  direct  con- 
trol over  security  issues. 

The  power  of  the  public  utility  commission  over  security 


Carolina  Public  Laws  (1917).  chapter  vxxxviii. 

'The  Pierson  Bond  Act.  1916  (New  Jersey). 

"Georgia  Acts,  1897,  p.  82;  Code  of  1911,  Sec.  445-451.  This  law  was 
upheld  by  a  decision  rendered  in  the  Supreme  Court  of  the  State,  De- 
cember 1,  1908,  in  the  effort  to  restrain  the  issuance  of  bonds  by  Albany, 
Georgia. 

4See  also  topic  in  Chapter  XIV,  on  Regulation,  for  a  discussion  of 
Federal  Regulation  of  Railroads,  which  is  not  considered  under  this 
topic.  This  omission  has  been  made  to  avoid  duplication.  Valuable 
citations  for  the  student  on  the  Regulation  of  Public  Utility  and  Rail- 
road Security  issues  are:  Mary  L.  Barren.  State  Regulation  of  the  Se- 
curities of  Railroads  and  Public  Service  Comnanies.  (Annals  of  Amer. 
Acad.  of  Pol  and  Soc.  Sci.,  vol.  Ixxvi.  March.  1918,  pp.  167-190)  ;  John 
Bauer,  The  Control  of  Return  on  Public  Utility  Investments,  (Pol.  Sci. 
Quart.,  vol.  xxxi.  1916.  pp.  260-288)  ;  Ralph  E'.  Heilman,  The  Develop- 
ment by  Commissions  of  the  Principles  of  Public  Utility  Capitalization, 
(Jour,  of  Pol.  Econ..  vol.  xxiii.  1915.  pp.  888-909)  ;  Milton  B.  Ignatius, 
The  Financing  of  Public  Service  Corporations.  (N.  ¥.,  1918)  ;  James  C. 
Bondbright,  Railroad  Capitalisation  (Columbia  University  Studies  in  His- 
tory, Economics  and  Law,  vol.  xcv,  1920,  p,  206). 


212  INVESTMENT  ANALYSIS 

issues  varies  from  the  mere  filing  of  notice  as  in  Pennsylvania 
and  Virginia,  to  the  complete  control  of  security  issues,  as  in 
Arizona,  California,  Illinois,  and  Vermont.1  The  laws,  as  a 
class,  lack  exactness.  In  a  number  of  the  states,  the  commis- 
sions have  had  to  give  an  unwarranted  interpretation  of  certain 
provisions  of  the  statutes  in  order  to  secure  any  semblance  of 
authority.  As  a  result  of  this  situation,  a  few  of  the  earlier 
decisions  of  the  commissions  in  these  particular  states  have 
shown  a  tendency  to  follow  the  mistaken  procedure  of  making 
inelastic  rules  and  never  departing  from  them.  Only  about 
one-fifth  of  the  state  commissions  have  been  given  any  con- 
siderable control  over  capitalization,  although  twenty  states 
require  the  public  utility  to  secure  permission  from  the  com- 
mission before  any  security  can  be  issued.  Of  this  number 
thirteen  are  required  by  statute  to  make  investigation  or  hold 
public  hearings  or  both. 

While  bonds,  mortgages  and  notes  occupy  a  minor  role  as 
compared  to  stock  in  all  public  utility  regulations,  the  ratio  of 
the  bonds  allowed  to  the  total  capitalization  is  no  less  important. 
Practically  all  the  commissions  have  in  some  way  restricted  the 
ratio  of  the  bonds  or  notes  to  the  total  amount  of  capitalization. 
No  general  rule  has  been  followed,  even  in  the  same  class  of 
public  utilities.  Individual  state  rulings  must  be  studied  to 
find  the  requirements  of  a  particular  state.  Reference  to  a 
number  of  these  rulings,  however,  will  give  a  fairly  clear  notion 
of  the  tenor  of  these  decisions. 

Massachusetts,  which  has  been  ultra-conservative,  does  not 
allow  an  excess  of  bonds  over  the  amount  of  the  outstanding 
stock.2  The  California  Commission  has  established  the  ratio  of 


*A11  the  states,  except  Delaware,  now  have  some  form  of  a  Public 
Utility  Commission.  Of  these,  twenty-four  states  have  given  their 
Commissions  some  power  of  control  over  capitalization.  These  states 
are:  Arizona,  California,  District  of  Columbia  (not  of  Railroads), 
Georgia,  Illinois,  Indiana  (not  of  Railroads),  Kansas,  Maine,  Mary- 
land, Massachusetts,  Michigan,  Missouri,  Nebraska,  New  Hampshire, 
New  Jersey,  New  York,  Ohio,  Pennsylvania,  Rhode  Island,  Texas,  Ver- 
mont, Virginia,  and  Wisconsin. 

'Massachusetts  Revised  Laws,  1902,  Chap.  121 ;  and  Acts  1908,  Chap 
G20,  Sec.  1. 


REGULATION  OF  SECURITIES  213 

bonds  at  70  per  cent1  of  the  total  capitalization.2  The  Cali- 
fornia Commission  has  also  emphatically  stated  that  it  will  not 
authorize  the  sale  of  either  stocks  or  bonds  for  the  sale  or  pur- 
chase of  a  public  utility  where  it  appears  that  the  company  will 
be  unable  to  earn  a  return  on  its  investment.3  This  commission 
has  been  especially  careful  to  point  out  that  sanction  of  a  secur- 
ity issue  under  these  requirements  is  not  for  the  purpose  of 
advising  investors.4  In  another  case  this  latter  commission 
placed  the  ratio  of  bonds  at  two  to  one  of  stock,  or  at  an  amount 
not  to  exceed  70  per  cent  of  the  proposed  expenditures.5  Maine 
has  made  the  same  ratio  of  two  to  one  in  a  street  railway  case," 
though  an  allowance  was  made  in  an  earlier  case  applying  to  a 
water  company.7  The  New  York  Commissions  of  the  First  and 
Second  Districts  have  ruled  that  the  amount  of  bonds  should 
be  fixed  by  the  margin  of  earnings  above  expenses,  but  this  rule 
has  not  been  strictly  followed.8  The  New  Jersey  Commission 
also  states  that  there  must  be  sufficient  evidence  that  fixed 
charges  can  be  met.  The  Wisconsin  and  Indiana9  statutes  pro- 
vide that  the  ratio  of  bonds  shall  be  a  "reasonable"  proportion 
of  the  capitalization,  but  leaves  the  decision  of  the  matter  in 
the  hands  of  the  Commission. 

Some  of  the  Commissions  have  fully  appreciated  the  neces- 
sity of  an  elastic  interpretation  of  the  amount  of  bond  issues. 
A  careful  study  of  the  trend  of  these  decisions  reveals  more 


1Public  Utility  Reports  Annotated,  1915,  A  787,  D  347.  The  statutes 
of  California  give  the  Railroad  Commission  the  power  to  issue  bonds 
above  the  amount  of  stock,  or  equal  to  or  above  the  amount  of  capital 
stock. 

2No  state  attempts  to  regulate  securities  issued  for  less  than  twelve 
months.  Arizona  and  California  are  the  only  states  which  require  the 
commission's  consent  for  refunding  of  shorter  maturities.  The  statutes 
also  almost  invariably  state  that  the  issue  shall  be  made  for  lawful  and 
corporate  purposes,  which  purposes  in  many  of  the  statutes  are  enum- 
erated in  detail.  California  has  also  made  frequent  requirement  of  spe- 
cified earnings.  [Re  Valley  Natural  Gas  Co.  (Cal.)  P.  U.  R.  1918  C  1.] 

3PuWic  Utility  Reports  Annotated,  1915,  B  38. 

'California  R.  R.  Commission,  Re.  Public  Service  Corporation  (Sept. 
3,  1917),  Decision  No.  4636. 

sIUd.,  Re.  Clear  Lake  R.  R.  Co.  (Nov.  13,  1917).    Decision  No.  4833. 

"Ibid.,  Re  Fresno  Interurban  R.  R.  Co.  (1915). 

''Maine  P.  U.  Report,  Re  Rumford  Falls  8  B.  Street  Ry.  Co.  (1917). 

*n)id.,  Re  Yarmouth  Water-Co.  (1915). 

•See  recent  case  Re  United  Gas  &  E.  Co.  (Ind.)  P.  U.  R.  (1918) 
E  311. 


214  INVESTMENT  ANALYSIS 

and  more  a  recognition  of  the  emphasis  that  should  be  placed 
upon  the  earning  power.1  The  dominant  question  then  is :  What 
fixed  charges  over  a  period  of  time  do  the  earnings  of  the  utility 
indicate  they  can  carry  with  safety?  In  new  enterprises,  or 
extensions,  estimation  of  earnings  of  course  becomes  a  larger, 
influence;  consequently  large  margins  for  the  safety  of  issues 
must  be  required.  Where  conservative  margins  are  enforced, 
ample  property  protection  is  seldom  lacking.  But,  even  where 
earnings  are  sufficiently  large,  according  to  this  standard,  too 
rigid  application  of  the  rule  in  new  construction  out  of  bonds, 
might  be  equally  objectionable.  Provisions  must  also  be  made 
against  such  a  contingency  as  a  reaction  in  earnings  in  the 
future.  No  investment  bank  ever  overlooks  this  fact. 

In  reorganization,  the  recapitalization  of  public  utilities  has 
been  based  on:  (1)  a  value  of  the  physical  property  fixed 
by  the  commission;2  (2)  earnings;3  (3)  capitalization  based 
upon  a  "fair  value"  of  the  property  and  earnings  of  the  cor- 
poration prior  to  receivership.'  As  would  be  anticipated  in 
fair-minded  rulings,  these  rules  have  been  given  considerable 
elasticity.  In  the  majority  of  reorganizations  the  recapitaliza- 
tion has  been  scaled  down.  Kansas,  which  has  generally  not 
allowed  an  over-issue  of  securities,"  has  permitted  an  excessive 
issue  in  reorganization,  when  it  has  already  been  approved  by 
another  state.6  Illinois  has  ruled  that  there  is  no  reason  why 
it  should  ascertain  the  value  of  subsidiary  properties,  as  long 
as  the  capitalization  of  the  consolidated  companies  does  not 
exceed  the  capitalization  of  the  independent  properties.  Upon 
the  face  of  it,  this  reasoning  seems  absurd.  On  the  other  hand, 
it  is  recognized  that  the  amount  of  capitalization  allowed  by 
any  one  of  these  commissions  is  primarily  dependent  upon  the 
method  of  valuation.  An  ultra-conservative  allowance  in  the 


1P.  8.  C.  Reports,  First  District,  N.  Y.,  vol.  v.,  p.  22. 
"Missouri,  Second  Annual  Report  Public  Utility  Commission,  p.  84, 
seq. 

"California,  Railroad  Commission  Opinions  $•  Orders,  No.  11. 
4Several  Commissions  have  adopted  this  as  their  standard. 
"Kansas,  P.  U.  R.  Re.  Mo.  P.  R.  Co.  (1917). 
"Kansas,  P.  U.  R.  Re.  St.  Louis  &  S.  F.  R.  R.  Co.  (1917). 


REGULATION  OF  SECURITIES  215 

amount  of  capitalization  to  property  values  might  be  wholly 
defeated  by  a  loose  method  of  valuation.1 

Again,  as  over-capitalization  is  chiefly  the  result  of  the  over- 
issuance  of  stocks,  the  prices  of  these  securities  are  the  more 
questionable.  The  procedure  of  Massachusetts  which  has  been 
followed  for  many  years  has  also  been  more  exacting  in  this 
respect  than  that  of  most  states,  as  it  requires  that  neither 
stocks  nor  bonds  of  public  utilities  shall  be  sold  for  less  than 
par.  It  also  requires  the  use  of  the  ' '  auction  clause ' '  and  other 
means  in  order  to  force  the  sale  of  securities  above  par.2 

Most  states  require  that  a  public  utility  issue  stocks  at  par, 
but  allow  the  issuance  of  bonds  at  a  discount.  This  control 
over  the  issuance  price  of  securities  is  usually  given  by  statute 
to  the  state  commission.  The  Missouri  and  New  Hampshire 
statutes  prescribe  the  sale  of  stock  at  par,  though  bonds  may  be 
sold  at  discount.  The  state  commissions  of  Indiana,  Maine,  New 
Jersey,  New  York,  and  Wisconsin  have  all  ruled  that  stock  must 
be  issued  at  par,  but  bonds  may  be  sold  at  a  discount.  Cali- 
fornia, Georgia,  and  Ohio  Commissions  permit  the  sale  of  both 
stock  and  bonds  below  par.  Where  the  amount  of  security  is 
not  used  as  the  basis  for  the  rate,  there  seems  to  be  no  justifica- 
tion for  not  allowing  sale  at  a  discount  in  the  case  of  securities 
of  an  established  company  (not  a  new  corporation).  It  may  be 
also  under  certain  market  conditions  a  serious  handicap  to  a 
corporation  if  it  is  forced  to  issue  its  securities  at  par.  It  may 
also  deprive  the  public  of  needed  service  if  the  corporation 
refuses  to  make  the  issue  under  these  conditions.  Where  the 
bonds  are  sold  at  a  discount  an  amortization  fund  should 
be  provided.  California,  Illinois,  Maryland,  Missouri,  New 
Jersey  and  New  York  Commissions  have  followed  the  practice 

Illinois,  P.  U.  R.  Re.  Illinois  Northern  U.  Co.  (1917).  If  no  par 
value  stock  can  be  issued  by  public  utilities  in  any  state,  this  fact  would 
have  to  be  taken  into  consideration  in  the  discussion  of  the  above  ques- 
tion. 

2In  Wisconsin  and  Indiana,  the  commission  has  permitted  bonds  to 
be  sold  as  low  as  75.  Missouri  at  70.  New  Jersey  at  70.  California  has 
varied  her  prices  between  new  and  established  corporations.  Prices  for 
new  corporations  have  been  as  low  as  80  and  in  old  corporations  from 
85  to  95.  Texas  does  not  allow  a  sale  price  of  bonds  for  less  than  the 
full  value. 


216  INVESTMENT  ANALYSIS 

of  requiring  that  such  an  amortization  fund  shall  be  created. 
The  Wisconsin  Commission  has  varied  in  its  practice.  Some 
of  the  more  recently  created  commissions,  as  in  Georgia,  do 
not  require  any  accounting  of  this  discount.  This  is  bad 
practice,  as  the  amount  of  the  discount  is  only  an  indirect 
interest  charge  that  should  be  added  to  secure  the  total  interest 
charge  of  the  issue. 

The  same  difficulties  also  arise  in  the  control  of  public  utility 
security  issues,  as  in  the  general  policies  of  taxation  or  any  other 
business  where  the  state  attempts  to  control  interstate  and  intra- 
state  business  by  the  same  statute  or  method  of  control.  A  few 
statutes  make  no  distinction  between  domestic  corporations  ope- 
rating in  or  outside1  the  state ;  some  give  the  power  of  issuance 
only  over  domestic  corporations2  operating  in  the  state  and 
others  assume  jurisdiction  over  all  corporations  doing  business 
within  the  state.3 

Under  the  present  methods  of  legislation,  two  different  com- 
missions may  give  separate  and  different  approval  to  the  same 
issue  of  securities.  Where  a  railroad  passes  through  a  number 
of  states,  the  large  powers  granted  to  one  commission,  the  dif- 
ferences in  decisions,  and  the  failure  of  common  agreement  may 
work  to  the  embarrassment  of  both  the  corporation  and  the 
public.4  Mutual  courtesy,  however,  is  creating  the  custom  of 
one  state's  respecting  the  findings  of  another  state  commission 
where  a  corporation's  properties  extend  into  or  through  that 
state,  as  with  railroads.  On  the  other  hand,  the  information 
on  which  a  commission  may  be  forced  to  pass  may  not  be  orig- 
inal information;  or  the  state  which  the  commission  represents 
may  be  more  rigid  in  its  exactions  than  the  state  granting  the 
privilege.  But,  why  should  a  commission  in  New  England  pass 
upon  the  building  of  a  waterworks  in  Oregon,  or  why  should 
Oregon  regulate  the  securities  of  a  corporation  organized  in 
Massachusetts?  As  frequently  happens  in  railroad  corporate 

1Arizona,  California,  Illinois,  Massachusetts,  and  Missouri.  See 
also  P.  U.  R.  1918  C,  p.  6 ;  Sec.  614-55 ;  P.  U.  R.  1918  B,  p.  265. 

2Maryland,  Maine,  Nebraska,  New  York,  and  Vermont. 

3District  of  Columbia,  Kansas,  Michigan,  New  Hampshire,  Ohio,  and 
Wisconsin. 

*First  Annual  Report  of  the  Arizona  Corporation  Commission,  p.  826. 


REGULATION  OF  SECURITIES  217 

organization,  it  may  be  that  no  property  is  located  in  the  state 
of  incorporation,  yet  the  state  determines  upon  the  issuance  of 
millions  of  securities  in  which  it  has  no  interest.  It  is  a 
clearly  defined  power  of  a  corporation  to  issue  securities  under 
the  authorization  of  the  state  of  incorporation  and  to  be 
restricted  only  by  a  foreign  state,  where  property  is  located  and 
a  specific  lien  is  made  on  this  property. 

Though  small  use  has  been  made  of  debentures  in  this  coun- 
try, the  present  position  of  the  courts  on  unsecured  debts  would 
lead  to  the  belief  that  this  form  of  security  could  be  used  in 
evading  the  unsecured  debt  requirement  of  the  law.1  Fear  of 
retaliation  would,  however,  probably  check  the  abuse  of  this 
privilege,  even  if  the  courts  should  maintain  it. 

The  vagueness  of  the  statutes  of  a  number  of  states  also 
adds  to  the  perplexity  of  determining  the  state's  own  assumed 
jurisdiction.  Further  complication  arises  where  the  statutes 
grant  power  only  to  domestic  corporations,  but  the  commis- 
sions extend  their  jurisdiction  over  securities  issued  on  proper- 
ties in  foreign  states.2  One  solution  of  these  difficulties  where 
interstate  interests  exist  seems  to  lie  in  Federal  incorporation, 
which  is  the  almost  universal  conclusion  reached  by  those  who 
have  given  the  problem  thorough  study.  This  point  was  em- 
phasized under  the  discussion  of  blue-sky  laws. 


E.   Heilman,   Control   of   Interstate   Utility   Capitalization, 
Journal  of  Political  Economy,  vol.  xxiv   (May,  1916),  p.  487. 
'Vermont,  1915. 


CHAPTER  XIII 
TAXATION  OF  SECURITIES 

The  present  chapter  is  primarily  devoted  to  the  problem  of 
the  direct  taxation  of  investment  securities.  The  purpose  is  not 
to  discuss  corporation  taxes  as  such,  excepting  where  these  taxes 
are  a  direct  part  of  the  tax  on  securities.  To  differentiate  the 
effect  of  the  two  taxes,  however,  is  often  difficult.  But  if  one 
is  to  have  a  complete  understanding  of  Federal  and  state  taxa- 
tion upon  securities,  he  must  run  the  whole  gamut  of  corpora- 
tion taxes.  Neither  is  the  purpose  of  this  discussion  to  suggest 
or  defend  any  tax  theory  of  securities  or  to  give  an  exhaustive 
treatise  on  the  existing  tax  laws.  The  primary  object  is  to 
state  the  more  fundamental  principles  involved  in  security  taxa- 
tion and  the  effect  upon  the  yield  of  the  security. 

In  dealing  with  existing  tax  laws,  one  is  confronted  with 
continuing  changes  which  soon  make  all  illustrative  material 
out  of  date.  The  inability  to  understand  fundamentals  or  an  un- 
willingness to  face  a  thorough-going  change  has  forced  the 
adoption  of  many  make-shifts  and  compromises.  As  a  conse- 
quence, many  of  the  artificial  distinctions  that  have  been  set  up 
between  tangible  and  intangible  property  (including  securities, 
etc.)  have  not  succeeded  in  effecting  any  more  equitable  distri- 
bution of  taxes.  Fundamentals,  however,  in  the  science  of  taxa- 
tion continue  the  same.1 

The  Basis  Upon  Which  the  Security  Tax  Is  Levied. — In  the 
discussion  of  the  effects  of  taxation,  it  is  first  necessary  that  the 
reader  shall  clearly  understand  the  interpretation  given  to 

JTo  the  reader  desiring  to  obtain  a  more  complete  understanding  of 
the  theory  of  taxes,  such  works  as  the  following  are  suggested :  Edwin 
R.  Seligman,  Essays  in  Taxation  (Macmillan  &  Co.,  1913)  ;  Hastings 
Lyon,  Principles  of  Taxation  (Houghton.  Mifflin  &  Co.,  1914)  ;  Carl  C. 
Plehn,  Introduction  to  Public  Finance  (Macmillan  &  Co,  1920)  ;  Henry 
C.  Adams,  Finance;  The  Science  of  Finance  (Henry  Holt  &  Co.,  1906). 

218 


TAXATION  OF  SECURITIES  219 

the  vame  of  properiy  or  security  upon  which  the  tax  is  based. 
Excepting  by  the  investor  who  has  investigated  the  financial 
system  of  a  state,  no  distinction  is  made  between  real  and 
market  valuation  or  between  actual  and  assessed  valuation. 
They  may  be,  and  generally  are,  quite  distinct,  and  an  under- 
standing of  this  distinction  is  the  first  essential  to  an  under- 
standing of  a  tax  on  securities.  In  most  states,  the  assessed 
valuation  is  given  as  a  certain  percentage  of  the  actual  fair  or 
market  value  of  the  property.  The  question  of  a  high  rate  or  a 
low  rate  of  a  tax  upon  securities,  must,  then,  always  be  inter- 
preted in  point  of  view  of  the  manner  of  assessment.  For  illus- 
tration, the  actual  amount  of  a  tax  of  2  mills  upon  a  $50,000 
security  assessed  at  100  per  cent  of  the  actual  fair  value  of  the 
security  is  four  times  as  great  as  the  tax  of  2  mills  on  a  $50,000 
security  assessed  at  25  per  cent  of  its  actual  fair  or  cash  value. 
The  consensus  of  opinion  now  is  that  an  assessment  of  full  value 
tends  to  a  fairer  assessment,  and  fortunately  the  present  trend 
in  state  legislation  is  to  accept  this  as  the  most  equitable  method.1 

In  addition  to  this  problem  of  valuation  one  finds  a  sharp 
distinction  frequently  made  in  the  method  of  evaluating  secur- 
ities or  intangibles  and  other  property.  In  levying  a  personal 
property  tax  a  value  other  than  that  of  the  market  is  often  used 
as  a  basis  on  which  to  determine  the  value  of  the  security. 
Why  a  different  basis  of  valuation  should  be  used  for  the  levy- 
ing of  this  tax  has  never  been  completely  explained.  The  value 
of  securities  like  all  other  property  is  based  in  the  long  run 
upon  the  earning  power,  i.  e.,  the  rate  of  return.  If  this  basis 
were  used,  as  far  as  taxes  are  concerned,  there  would  be  no 
difference  whether  the  security  were  issued  below  or  above  par 
or  whether  the  price  fluctuated  after  its  issue.2 

The  Effect  of  the  Tax  Levy. — The  two  forms  of  taxes 
directly  affecting  bonds  are  the  personal  property  tax  and  the 
income  tax;  the  former  is  levied  on  the  principal  of  the  bond, 
the  latter  on  the  interest  of  the  bond.  For  illustration,  in  the 


*As  only  one  class  of  items — namely,  securities — is  considered,  it  is 
not  necessary  to  discuss  the  ejfect  of  the  various  items  that  enter  into 
the  valuation  of  the  wealth  of  a  state. 

2Hastings  Lyon,  Principles  of  Taxation  (3914),  p.  95. 


220  INVESTMENT  ANALYSIS 

personal  property  tax,  if  a  2  per  cent  tax  is  levied  it  would  be 
on  the  principal  amount,  say  of  a  $500  bond.  This  would 
amount  to  a  tax  of  $10.  If  the  nominal  rate  on  the  bond  were  5 
per  cent  (or  $25)  the  net  yield  would  then  be  $25-$10  or  an 
actual  net  income  on  this  bond  of  $15  for  the  year  to  the  holder. 
If  a  levy  is  made  on  the  income  by  the  state,  to  secure  an  equiv- 
alent return  to  the  state  a  tax  of  40  per  cent  would  have  to  be 
levied  on  the  $25  income  of  the  bond.  In  either  case  the  pay- 
ment of  the  tax  must  be  deducted  from  the  interest  on  the  bond. 

To  enable  the  security  holder  to  obtain  the  full  amount  of 
the  nominal  income  of  5  per  cent,  the  above  $500  bond  must  be 
purchased  at  a  discount.  The  amount  of  this  discount  will  be 
equivalent  to  the  amount  of  the  capitalization  of  the  annual  tax 
paid.  In  an  original  issue  of  bonds,  the  corporation  is  thus 
forced  to  pay  a  larger  return  on  funds  borrowed.  Or  if  the 
original  purchaser  had  bought  the  bonds  before  the  tax  was 
levied  and  then  was  forced  to  sell  it,  he  would  suffer  the  loss  of 
the  capitalized  amount  of  this  tax  in  the  sale  of  his  bond. 
Applying  this  capitalization  principle  to  the  $500  bond  above, 
the  sale  price  of  the  bond  would  be  lowered  to  $300.  That  is  with 
the  capitalization  of  the  $10  tax  at  5  per  cent  (the  nominal  rate 
on  the  bond)  would  be  $200;  deducting  this  from  $500  leaves 
$300,  the  price  at  which  the  bond  will  sell.  The  new  holder, 
out  of  the  net  balance  of  $15  left  after  deducting  the  $10  tax 
from  the  $25  nominal  amount  paid,  will  have  in  this  $15  net 
return  a  return  of  5  per  cent  on  his  $300  investment. 

If  the  corporation  originally  issuing  bonds  under  these  con- 
ditions desired  to  sell  them  at  par,  the  rate  necessary  to  make 
up  this  tax  would  have  to  be  added  to  the  interest  rate.  In  the 
above  bond,  if  the  principal  were  taxed  to  realize  a  tax  of  $10, 
a  rate  would  have  to  be  added  to  the  yield  to  increase  the 
yield  $10  a  year,  or  a  total  amount  of  $35  to  the  holder.  In 
order  for  the  $500  bond  to  yield  $35  a  rate  of  7  per  cent  would 
have  to  be  paid  by  the  corporation  for  its  money.  If  the  5 
per  cent  rate  is  maintained  by  the  corporation,  the  bond  will 
sell  at  a  sufficiently  low  rate  to  yield  the  7  per  cent  to  the 
holder  of  the  bond.  Consequently,  whether  the  corporation 
uses  either  one  or  the  other  of  these  methods  the  cost  of  its 
money  will  be  7  per  cent.  Unless  the  corporation  is  willing 


TAXATION  OF  SECURITIES  221 

to  meet  this  demand  for  a  higher  yield  for  this  particular 
risk,  capital  will  be  diverted  to  other  fields. 

The  More  Common  Methods  of  Taxing  Mortgages,  Bonds, 
and  Other  Securities. — The  methods  or  plans  of  taxation  and 
their  actual  effect  upon  the  yield  of  the  security  can  only  be 
discussed  from  their  general  rather  than  their  specific  applica- 
tion. If  every  security  sold  in  Chicago,  for  example,  were  con- 
fined to  this  market  and  only  subject  to  the  local  state  laws,  a 
fairly  accurate  mathematical  rule  could  be  established.  But 
this  is  not  the  case,  for  general  market  influences  affect  the  Chi- 
cago market.  And  in  every  state  to  which  a  security  may  be 
brought,  a  different  tax  law  exists.  If  a  tax  exists  in  one  state 
and  not  in  an  adjoining  state  the  effect  is  obviously  to  drive 
securities  from  the  state  with  the  tax.  While  general  classifica- 
tions of  these  laws  may  be  made,  these  individual  differences  in 
application  give  different  results  in  net  yield.  And  one  need 
not  argue  the  importance  of  the  fractional  differences  in  the  net 
yields  of  high  class  securities. 

The  vagueness  or  the  very  character  of  the  law,  as  frequently 
as  anything  else,  makes  it  impossible  to  determine  the  effect  of 
a  tax.  Mr.  Roy  Osgood  has  given  a  good  illustration  of  this  in 
the  Chicago  market: 

"As  a  typical  illustration  of  the  difficulty  of  computing  the 
influence  of  a  state  tax  on  securities  consider  the  situation  in 
Illinois.  This  state  has  a  general  property  tax  law  and  the 
constitution  does  not  allow  classification  of  property  for  tax 
purposes.  For  some  years  the  tax  rate  has  averaged  around  2 
per  cent  on  the  actual  value  of  bonds.  The  rates  for  the  several 
counties  have  varied,  but  in  Cook  County,  where  Chicago  is 
located  and  where  the  major  part  of  the  personal  property  of 
the  state  has  its  tax  situs,  2  per  cent  has  been  the  rate  for  all 
practical  purposes.  Applying  the  capitalization  theory,  5  per 
cent  industrial  bonds  owned  in  Chicago,  when  the  normal  invest- 
ment return  on  such  bonds  is  5  per  cent,  ought  to  sell  at  60  and 
new  issues  of  such  bonds  ought  to  bear  7  per  cent.  Neither  of 
these  results  has  followed,  so  the  tax  influence  is  overcome  by 
other  influences.  Such  bonds  have  sold  for  practically  the  gen- 
eral market  price  of  securities  of  like  rate  and  character.  It  is 
true  in  Illinois,  as  in  other  ^states  having  an  unclassified  prop- 
erty tax,  that  comparatively  little  personal  property  is  reached 
by  taxation  so  that  the  effect  of  the  tax  is  negligible  compared 
with  the  effect  of  the  condition  of  the  security  market.  The 


222  INVESTMENT  ANALYSIS 

factor    of   competition   undor   such   circumstances   completely 
obscures  the  effect  of  the  tax  rate. 

If,  however,  the  effect  of  "he  tax  rate  be  considered  in  its 
application  to  securities  of  a  local  nature  having  a  restricted 
local  market,  the  effect  might  be  more  pronounced.*'1 

Out  of  the  efforts  to  secure  a  modification  of  the  general 
property  tax  on  intangibles,  there  have  evolved  a  number  of 
modifications  along  the  same  general  lines,  none  of  which  can 
really  be  said  to  be  a  success.  The  majority  of  these  modifica- 
tions made  in  the  constitution  and  statutes  have  related  to  civil 
loans  issued  in  the  state,  and  to  mortgages  and  mortgage  bonds 
on  real  estate  within  ihe  state.  With  the  exception  of  the 
income  taxes  and  those  directly  affecting  civil  loans  few  changes 
have  been  made  in  the  laws  affecting  the  direct  taxation  of 
bonds. 

The  two  important  plans  most  widely  accepted  in  mortgage 
taxation,  although  there  is  considerable  overlapping  of  land 
and  mortgage  tax  classification,2  are:  The  Classified  Property 
or  Low  Rate  Plan,  and  the  Recordation  Method.  The  majority 
of  the  states,  however,  still  continue  to  tax  mortgages  under 
the  old  general  property  tax.8  The  differentiation  most  com- 


JRoy  C.  Osgood,  The  Effect  of  Taxation  on  Securities,  The  Annals 
of  the  American  Academy  of  Political  and-  Social  Science,  vol.  Ixxxviii 
(March,  1920),  p.  159.  (The  above  tax  law  referred  to  by  Mr.  Osgood 
will  no  doubt  be  changed  if  the  present  efforts  to  secure  a  revision  of 
the  Constitution  succeed.) 

2In  1910  more  than  three-fourths  of  the  state  constitutions  prohibited 
the  classification  of  property  for  taxation.  About  one-half  of  the  states 
now  permit  such  a  classification  (January  1,  1920). 

"The  following  states  tax  all  mortgages :  Arizona,  Arkansas.  Florida, 
Georgia.  Illinois,  Indiana,  Kansas,  Kentucky,  Missouri  (with  excep- 
tions). Montana.  Nevada.  New  Mexico  (new  act  pending  January.  1920), 
North  Carolina.  Ohio,  Oklahoma,  Oregon,  South  Carolina.  South  Dakota, 
Tennessee.  Texas,  Virginia  and  West  Virginia.  The  stattites  of  1919  of 
South  Dakota  and  Kentucky  provide  for  a  so-called  registry  tax  which  is 
a  recording  tax. 

The  states  not  taxing  mortgages  on  real  estate  within  the  state  are : 
Colorado.  Louisiana,  Maine  (bills  now  pending  to  tax  personal  property 
quite  likely  to  pass),  Maryland,  Massachusetts,  Nebraska  (if  tax  free 
clause  in  instrument).  New  Hampshire  (if  rate  on  mortgage  is  not  over 
5  per  cent),  New  Jersey  (except  railroad  bonds  outside  of  state),  Ver- 
mont (on  property  in  state,  if  rate  is  not  in  excess  of  5  per  cent),  and 
Wyoming. 

The  following  states  have  no  tax  on  mortgages:  California.  Dela- 
ware, Idaho,  Mississippi  (if  the  rate  on  obligation  does  not  exceed  6  per 
cent),  Utah,  and  Washington.  Of  these.  California,  Idaho,  and  Utah  tax 
bonds  secured  by  realty  outside  of  the  state. 

See  also  Recording  Tax  footnote,  and  Income  Tax  footnote. 


TAXATION  OF  SECURITIES  223 

mon  in  the  past  has  been  between  mortgages  upon  real  estate 
in  the  state  and  mortgages  on  real  estate  outside  of  the  state. 
In  some  states,  bonds  issued  upon  real  estate  are  given  the  same 
classification  as  mortgages.  In  others,  bonds  and  mortgages  are 
given  an  individual  classification.  The  newest  departure  from 
the  old  form  of  taxing  bonds  under  the  general  property  tax 
is  the  Debt  Secured  Tax  statutes,1  which  are  all  Low  Rate  Plans. 
Two  other  forms  of  taxes  which  are  not  a  direct  security  tax, 
but  a  tax  upon  income,  and  have  a  more  important  effect  on  the 
income  of  the  individual  holder  of  securities,  are  the  Income 
Tax  and  Inheritance  Tax.  As  the  Transfer  Tax  applies  only 
to  stock,  it  is  not  necessary  to  discuss  it  in  this  chapter. 

The  Low  Rate  plan  for  the  direct  taxation  of  all  mortgages 
has  had  the  widest  acceptance  of  any  of  the  special  plans  of  tax 
on  investment  securities.  The  method  of  taxation  is  the  same, 
as  in  the  general  property  tax,  except  that  a  lower  rate  is 
adopted.  Pennsylvania,  which  has  used  this  plan  the  longest, 
taxes  all  forms  of  indebtedness  and  stocks  on  the  same  basis. 
Where  exemption  privileges  are  granted,  they  are  usually  to 
capital  stocks  of  domestic  corporations.  The  real  purpose  of 
this  plan,  as  with  all  of  those  suggested  here,  is  to  encourage  a 
declaration  of  all  personal  property. 

Of  all  the  plans  for  the  taxation  of  mortgages,  the  Recorda- 
tion  Method2  is  the  simplest  in  administration.  From  the  view- 
point of  the  mortgagee,  it  has  the  advantage  of  an  assured  cer- 


'Michigan,  Minnesota.  Missouri  and  North  Dakota  have  all  adopted 
what  they  term  the  Debt  Secured  Tax ;  as  previously  stated,  however,  it 
does  not  vary  in  principle  from  the  Low  Rate  Plan.  Oklahoma  has  in 
effect  the  same  thing  in  its  flat  rate  of  2  per  cent  of  the  face  value  of 
bonds,  and  Iowa  has  a  flat  rate  of  5  mills  on  moneys  and  credits.  New 
York,  which  has  been  adopting  a  number  of  different  taxes  in  rapid 
succession,  passed  in  turn  a  Mortgage  Recording  Tax,  a  Debt  Secured 
Tax,  a  so-called  Investments  Tax,  and  lastly,  an  Income  Tax,  each 
superseding  in  whole  or  in  part  the  previous  tax. 

2Alabama  has  a  mortgage  recording  tax  for  mortgages  on  real  estate 
in  the  state.  Iowa  has  a  special  tax  of  5  mills  on  all  mortgages.  Penn- 
sylvania and  Rhode  Island  tax  all  mortgages  4  mills  per  annum.  States 
having  income  taxes  reach  the  income  of  the  mortgage  by  this  regular 
source.  Kentucky  imposes  a  tax  of  20  cents  on  each  $100  of  the  mortgage 
on  real  estate,  if  it  does  not  mature  in  five  years.  Ohio  exempts  mortgages 
secured  by  property  in  the  state*  if  registered,  and  a  fee  of  %  of  1  per 
cent  is  paid  in  addition  to  the  recording  fee.  Tennessee  has  a  so-called 
privileged  tax  of  15  cents  per  $100  on  mortgages  over  $1.000,  which  must 
be  paid  before  the  instrument  is  recorded.  North  Dakota  has  modeled 
its  law  after  that  of  Minnesota. 


224  INVESTMENT  ANALYSIS 

tainty  of  the  tax  being  shifted  to  the  mortgagor.  This  plan, 
which  was  originally  adopted  by  most  states,  has  since  been 
either  modified  or  supplanted  by  other  laws.  Minnesota  was 
among  the  first  to  adopt  a  modified  recording  tax.  This  tax 
has  attracted  considerable  attention.  A  discrimination  is  made 
under  the  mortgage-recording  clause  in  this  law  between  indebt- 
edness on  Minnesota  real  estate  and  other  indebtedness.  If 
either  real  estate  bonds  or  mortgages  upon  Minnesota  realty  are 
recorded  and  pay  a  fee  of  1.5  mills  on  mortgages  of  less  than 
five  years  and  2.5  mills  on  mortgages  of  more  than  five  years 
duration,  these  securities  are  exempt  from  further  taxation.  All 
other  securities  are  subject  to  the  3  mill  tax,  and  in  comparison 
with  mortgages  taxed  under  the  Minnesota  realty  recording  tax 
are  discriminated  against  to  an  extent  which  seems  hardly  jus- 
tifiable. 

The  Michigan  recording  tax,  which  applies  to  the  tax  on 
loans  secured  by  liens  on  real  estate  only,  was  adopted  as  a 
modification  of  the  former  New  York  recording  tax.  The 
Michigan  tax  is  compulsory,  and  substitutes  a  single  five-mill 
recording  tax  in  place  of  the  old  recording  fee  and  annual  tax, 
from  which  this  tax  must  be  kept  distinct.  Ohio's  law,  which 
is  a  modified  form  of  the  recording  tax,  was  adopted  for  the 
purpose  of  avoiding  double  taxation  on  mortgages  and  real 
estate.1 

The  most  recent  tax  reform  which  has  had  an  important 
effect  upon  securities  is  the  income  tax.  This  tax,  which  has 
long  been  used  in  Europe,  is  not  new  to  this  country.  Approxi- 
mately twenty  states  up  to  the  adoption  of  the  "Wisconsin  law 
in  1911  had  experimented  with  an  income  tax.2  These  tax 
systems  were  usually  applied  only  to  incomes  which  were  not 
reached  by  other  taxes,  such  as  salaries.  Lack  of  centralization 


'Massachusetts,  for  illustration,  has  a  registration  charge  of  $3.00 
per  annum  which  exempts  from  any  other  taxes  when  the  tax  is 
secured  by  tangible  property  whether  within  or  without  the  Common- 
wealth. Alabama  and  South  Dakota  also  have  a  similar  statute. 

2A  list  of  the  states  which  have  adopted  the  income  tax  is  not  given 
here  for  the  reason  that  almost  as  soon  as  this  book  leaves  the  press 
such  a  list  would  be  antiquated ;  but  any  investment  banker  can  readily 
furnish  such  a  list.  These  conditions  apply  to  all  personal  property 
taxes  treated  in  this  chapter. 


TAXATION  OF  SECURITIES  225 

in  the  organization  and  application  of  these  taxes,  however, 
doomed  these  systems  from  the  beginning,  regardless  of  their 
other  faults.  Consequently,  this  form  of  taxation  was  consid- 
ered impractical  for  a  long  time. 

The  renewed  emphasis  upon  taxation  with  the  increasing 
demands  for  revenue  and  the  greater  appreciation  of  the  injus- 
tice of  the  general  property  tax  has  revived  the  agitation  for 
this  tax.  The  adoption  of  a  Federal  Constitutional  amendment 
and  finally  an  income  tax  law,  as  well  as  the  adoption  of  the 
tax  by  a  number  of  the  states,  indicates  a  permanent  acceptance 
of  this  principle  of  taxation.  The  adoption  of  this  tax  by 
Massachusetts  and  New  York,  the  two  leading  investment  cen- 
ters of  the  country,  will  make  the  income  tax  effective  for  a 
very  large  amount  of  holdings.  Of  the  nearly  sixty  foreign 
countries  and  their  minor  political  divisions  which  have 
adopted  the  income  tax,  none  have  abandoned  it.  The  large 
number  of  methods  and  practices  now  used  in  levying  this 
tax  indicates  that  these  laws  are  still  in  the  experimental  stage 
and  many  new  adaptations  must  grow  out  of  practical  experi- 
ence. And  as  these  laws  are  in  their  transitional  stage,  too 
much  emphasis  cannot  be  placed  upon  the  present  operation 
of  the  law.  A  large  number  of  corrections  must  be  made  in 
the  existing  statutes.* 

The  original  Federal  Income  Tax  Law  was  adopted  in  1913, 
and  has  been  revised  three  times  at  the  present  writing,  and  is 
quite  likely  soon  to  receive  other  revisions.  The  most  effective 
changes  in  the  tax  upon  the  income  of  individuals,2  which  con- 

*The  importance  of  these  statutes  has  caused  the  important  banks 
in  every  state  having  an  investment  business,  to  publish  numerous 
pamphlets  explaining  the  statutes  and  their  operation.  These  may  be 
easily  secured  by  the  reader. 

2While  the  following  rates  and  exemption  will  be  changed — thus 

making  this  summary  obsolete — they  will  serve  for  illustrative  purposes. 

INCOME  TAX  LAW  SIGNED  FEBRUARY  24,  1919 

The  Rates  of  Taxation  on  the  Income  of  Individuals 

A — Normal  Tax  on  citizens  and  residents  of  the  United  States: 

For  1919,  and 
For  1918  thereafter 

On  first  $4,000,  in  excess  of  credits 6%  4% 

Balance  over  $4,000 ^. 12%  8% 

For  non-resident  aliens : 
On  total  income  from   sources  in  the  United 

States  in  excess  of  credits 12%  8% 


226  INVESTMENT  ANALYSIS 

cerns  us  here,  will  doubtless  come  in  the  eventual  lowering  of 
the  rates.  Under  the  present  law  the  tax  upon  securities1  (held 
by  a  married  man  with  no  children  and  without  income  other 
than  that  from  securities)  would  normally  range  from  $60  on 
an  income  of  $3,000  to  $703,030  on  an  income  of  $1,000,000. 
Because  of  the  graduated  rates,  it  is  impossible  to  indicate  any 
general  effect  upon  security  prices.  While  the  tax  is  measured 
on  the  aggregate  income,  the  effect  upon  the  yield  to  the  holder 
having  a  total  of  $5,000  in  bonds  to  the  holder  of  $1,000,000  in 
bonds  is  quite  different.2  The  principle  as  applied  to  the  pres- 
ent law  is  illustrated  in  the  following  table: 

Nominal  Rate  and  Net  Yields  if  Securities  are  Sold  at 
Incomes  Par  and  Not  Taxed 

Taxed  4%  5%  6% 

Net  yields  when  taxed  under  the  present  law  with  individuals 

having  these  respective  incomes. 

$     5,000  3.904  4.880  5.856 

10,000  3.764  4.705  5.646 

50,000  3.265  4.081  4.897 

100,000  2.752  3.441  4.129 

The  present  Wisconsin  Income  Tax,  the  oldest  of  the  income 
taxes,  is  a  progressive  income  tax,  and  practically  all  forms  of 

B — Surtaxes  are  imposed  on  all  incomes  over  $5,000.  It  starts 
with  1  per  cent  on  net  incomes  from  $5.000  to  $6,000.  and  increases  1 
per  cent  for  every  $2,000  increase  of  income  up  to  $100,000,  thence  by 
smaller  advances  until  the  maximum  of  65  per  cent  on  $1,000,000  is 
reached. 

C — Personal  Exemptions  are  $1,000  for  single  persons  and  $2,000 
for  married  persons,  the  head  of  a  family  being  allowed  an  additional 
exemption  of  $200  for  each  dependent. 

Other  general  exemptions  are  all  forms  of  insurance  premiums  and 
payments,  value  of  property  from  gift  or  bequest  (not  income  from), 
interest  on  bonds  of  a  state,  territory,  or  subdivision  thereof.  District  of 
Columbia  and  designated  United  States  bonds,  income  of  foreign  govern- 
ments from  investments  in  the  United  States,  accident  and  health  insur- 
ance payments,  arid  amounts  received  from  military  service  and  other 
service  essential  to  conducting  of  war.  State  officials  are  presumably 
exempt  from  taxes  on  compensation  received  from  the  state. 

D — The  list  of  deductions  allowed  and  to  be  made  in  obtaining  net 
income  are  exceedingly  complicated  and  can  best  be  procured  from  the 
statute  and  the  treasury  rulings. 

1Because  of  the  constant  change  in  Rulings  6j/  the  Internal  Reve- 
nue Department  information  is  not  complete  without  consulting  such 
services,  as  Corporation  Trust  Company  Tax  Service,  Prentice-Hall  Tax 
Service,  etc. 

'The  effect  of  Exemption  Privileges  are  discussed  under  that  topic. 


TAXATION  OF  SECURITIES  227 

income  are  taxed  under  this  statute.  Income  of  corporations 
not  subject  to  this  tax  is  charged  against  the  person,  or  corpora- 
tion, etc.,  receiving  that  income,1  with  an  exemption  of  any 
direct  tax  on  any  form  of  personal  property.  The  tax  is  also  a 
substitute  for  the  personal  property  tax.  If  a  personal  property 
tax  is  paid,  the  amount  of  that  tax  is  deducted  from  the  income 
tax.2  Thus,  if  the  income  tax  were  $50  and  a  personal  prop- 
erty tax  of  $25  had  been  paid,  only  $25  would  be  due  on  the 
income  tax.  The  same  deduction  would  be  allowed  the  cor- 
poration, where  a  tax  is  paid  on  property. 

The  Massachusetts  Act  of  1917,  which  provides  for  a  flat  6 
per  cent  rate  on  intangible  property,3  and  1%  per  cent  upon 
income  derived  from  annuities,  trades,  and  professions,  is  a 
partial  income  tax.  The  effect  of  this  has  been  a  decrease  from 
the  approximated  average  under  the  old  law.  The  effect  of  such 
a  tax  is,  of  course,  perfectly  apparent. 

The  Massachusetts  tax,  unlike  the  Wisconsin  tax,  is  not  a 
progressive  tax.  Interest  on  bonds  is  generally  taxed  except  on 
bonds  and  notes  secured  by  real  estate  and  taxable  as  real  estate 
in  the  state,  but  only  to  the  amount  exceeding  the  value  of  the 
mortgaged  real  estate,  United  States  bonds  and  the  civil  issues 
of  the  state  and  certain  of  its  minor  civil  divisions.  Dividends 
on  corporations  are  taxed,  except  stock  in  Massachusetts  cor- 
porations, national  banks  and  foreign  corporations  whose  fran- 
chises are  subject  to  a  tax  in  the  state.  And  primarily,  all 
dividends  of  voluntary  associations  are  taxed,  unless  the  volun- 
tary associations  file  agreement  to  pay  the  tax.  It  is  not  safe 
to  assume  that  the  shares  are  exempt,  until  evidence  is  had  of 
the  filing  of  the  agreement.*  There  is  also  a  tax  of  3  per  cent 


'The  rate  is  progressive,  beginning  with  1  per  cent  on  the  first  $1.000 
and  increasing  to  6  per  cent  on  $5,000.  Exemptions:  $800  for  indi- 
viduals without  families ;  $1.200  with  families ;  and  $200  for  each  child. 

See  T.  S.  Adams.  The  Wisconsin  Income  Tax,  American  Economic 
Review,  vol.  i,  No.  4  (Dec.  1911),  pp.  906-918. 

Wisconsin  Income  Tax  Laws,  Chap.  658.  Laws  1911.  Sec.  1087. 

3See  Act  for  rates  on  earned  income  in  1917,  Income  Tax  Act  1917, 
sec.  v.  See  a  good,  short,  general  discussion  of  the  Act  by  E.  J.  Bullock 
in  an  Introduction  to  a  cony  of  the  statute  issued  by  the  Old  Colony 
Trust  Company,  Boston  (1916>- 

4The  taxpayer  may  make  deductions  for  indebtedness  of  such  pro- 
portion of  the  interest  paid  on  his  total  indebtedness  as  the  income 


228  INVESTMENT  ANALYSIS 

upon  the  excess  of  gains  over  losses  from  the  purchase  or  sale 
of  intangible  personal  property.  Both  the  broker  and  indi- 
vidual speculator  are  subject  to  this  tax.  The  shifting  possible 
under  this  partial  income  tax  of  Massachusetts  is  one  of  its 
serious  drawbacks  and  must  put  it  to  a  severe  test  when  judged 
by  the  canons  of  just  taxation.  If  state  tax  reforms  move  for- 
ward with  any  great  rapidity,  this  statute  will  undoubtedly  be 
amended.  The  New  York  law,  which  closely  follows  the  Federal 
Income  Tax  Law  approved  in  1919,  is,  like  the  Wisconsin  law, 
a  progressive  income  tax.1  Other  instances  might  be  cited  but 
these  are  sufficient  to  indicate  the  trend  of  the  income  tax  in 
relation  to  investment. 

While  the  inheritance  tax2  is  not  a  direct  tax  upon  securities, 
the  investor  who  is  purchasing,  primarily,  for  his  legacy,  must 
give  it  careful  thought.  This  particularly  applies  to  the  exemp- 
tions allowed  by  the  different  states  and  becomes  increasingly 
true  as  the  holdings  grow  in  amount.  As  the  larger  legacies 
have  been  confined  to  a  narrow  group  of  cities  in  the  New 
England  and  Middle  Atlantic  states,  and  the  statistics  are  rela- 
tively new,  no  very  wide  popular  interest  has  been  taken  in  this 
problem.  But  with  the  increasing  number  of  fortunes,  espe- 
cially those  of  moderate  size,  and  the  increasing  interest  in  taxes, 
attention  is  being  directed  to  the  effect  of  these  taxes  upon 
securities.  What  the  direct  effect  upon  security  values  is,  it 
will  be  difficult  if  not  impossible  ever  to  measure  accurately. 

The  three  most  important  practical  points  for  the  prospec- 
tive legator  to  study  are :  ( 1 )  whether  the  tax  is  upon  the  estate 

which  he  derives  from  taxable  tangible  property  bears  to  his  income 
from  all  sources ;  and  an  exemption  of  $300  of  income  from  tangible 
property  is  allowed  to  persons  whose  total  income  does  not  exceed  $GOO. 

JThe  tax  is  imposed  at  graduated  rates  as  follows :  The  first  $10.000 
at  1  per  cent;  next  $40,000  at  2  per  cent;  over  $50.000  at  3  per  cent. 
Securities  exempted  are :  obligations  of  the  United  States  and  its  posses- 
sions ;  securities  under  the  Federal  Farm  Loan  Act  of  July  17,  1916 ; 
state  War  Finance  Corporation  bonds  of  New  York,  and  the  bonds  of 
its  political  subdivisions.  Personal  exemptions  of  $1.000  for  single  per- 
sons, and  $2,000  for  the  heads  of  families  are  allowed. 

2For  a  complete  discussion  of  the  operations  of  the  Inheritance 
Taxes  see  Max  West,  The  Inheritance  Tax,  Columbia  University  Studies 
in  History  of  Economics  and  Public  Law  (2nd  ed.  1908).  Also  Edwin 
R.  A.  Seligman,  Essays  on  Taxation,  Chap.  V  (Sth  ed.  1912)  pp.  126-141. 
More  than  four-fifths  of  the  states  now  have  some  form  of  an  inheri- 
tance tax. 


TAXATION  OF  SECURITIES  229 

as  a  whole,  or  on  the  individual  shares  received  by  the  legatee; 
(2)  whether  the  character  and  the  amount  of  the  tax  rate  are 
equitably  distributed;  (3)  whether  the  legator  at  his  present 
residence  will  be  subject  to  more  than  one  inheritance  tax. 

The  general  practice  in  the  United  States  has  been  to  tax 
the  estate  as  a  whole,  though  the  principle  of  taxing  the  shares 
received  by  the  individual  is  gaining  wider  acceptance.  There 
seems  to  be  no  reason  why  discrimination  should  be  made  against 
an  employee  receiving  $5,000  from  a  $1,000,000  estate,  as  com- 
pared with  one  receiving  $5,000  from  a  $100,000  estate,  by  tax- 
ing the  former  several  per  cent  more  than  the  latter.1  Tax  rates 
on  inheritance  in  the  United  States  have  also  been  increased 
and  the  amount  of  the  exemption  has  been  lowered  especially 
in  the  collateral  inheritance  (that  of  legatees  not  lineal  descend- 
ants). The  movement  toward  the  progressive  inheritance  tax 
has  also  made  a  decided  progress.  The  range  used  by  the 
states  is  wide,  the  tax  varying  from  1  to  5  per  cent  on  legacies 
inherited  by  lineal  descendants  and  1^  to  25%  on  collateral 
legacies.  The  tendency  in  legislation  is  toward  a  rapid  advance 
in  the  increase  of  rates  on  the  latter  legacies.  Exemptions  for 
the  taxes  on  collateral  inheritances  average  from  $100  to  $2,000, 
and  direct  inheritance  from  $2,000  to  $10,000.  A  few  make 
exemptions  as  high  as  $25,000.2 


JEdwin  R.  A.  Seligman,  Essays  on  Taxation  (8th  Ed.),  p.  136.  Also 
see  Report  of  the  Special  Tax  Commission  of  'New  York,  of  which  Pro- 
fessor Seligman  was  a  member. 

2One  of  the  serious  difficulties  growing  out  of  the  muddled  state 
of  the  inheritance  tax  laws  is  the  duplication  resulting  from  over- 
lapping jurisdictions.  Mr.  W.  D.  T.  Trefry,  whose  recommendations 
were  followed  by  the  Massachusetts  legislature,  tersely  and  aptly  states 
our  whole  problem  of  duplication  in  inheritance  taxes,  in  his  annual 
report  for  Massachusetts  (January,  1912)  : 

"Investors  all  over  the  country  are  carefully  seeking  for  securities 
which  are  subject  to  no  legacy  tax  in  a  state  other  than  that  of  the 
domicile  of  the  owner.  If  Massachusetts  shall  cease  to  tax  non-resident 
estates  on  account  of  their  share  in  Massachusetts  corporations,  these 
shares  will  become  much  more  attractive  for  foreign  investors  .  .  . 

"We  now  tax  a  non-resident  estate  with  reference  to  any  savings  of 
other  bank  accounts  in  this  commonwealth,  on  account  of  any  bonds  of 
whatever  nature  which  at  the  time  of  death  of  the  owner  are  physically 
present  in  this  commonwealth,  anjl  on  account  of  any  debt  due  him  from 
a  resident  of  Massachusetts.  It  may  be  that  such  non-resident  has 
never  lived  in  Massachusetts ;  that  he  puts  his  money  and  securities  in 
the  safe-keeping  of  our  banks  for  his  convenience  only ;  that  his  loans 


230  INVESTMENT  ANALYSIS 

The  Federal  Estate  Tax  originally  passed  as  a  part  of  the 
Revenue  Act  of  1916  has  been  subjected  to  three  revisions  and 
is  very  likely,  with  the  new  changes  which  will  be  made  in  the 
revenue  act,  also  to  be  changed.1  The  Federal  tax  is  not  placed 
upon  the  property  but  upon  the  transfer.  It  is  levied  upon 
the  entire  net  estate,  and  the  tax  must  be  paid  out  of  the  estate 
before  the  latter  is  distributed.  The  New  York  inheritance 
tax,  to  the  contrary,  is  an  individual  inheritance  tax.  It  is  a 
tax  on  the  right  of  succession,  and  the  tax  is  levied  on  the  basis 
of  the  market  value  of  the  property  and  the  character  of  the 
kinship.  The  Federal  tax  is  placed  upon  all  estates  which 
exceed  $50,000,  except  that  for  the  holdings  of  a  foreign  resi- 
dent, the  tax  is  applied  only  to  that  part  of  the  property 
located  in  the  United  States.  The  tax  is  payable  within  one 
rear  after  death.12 


to  Massachusetts  residents  are  good  business  for  him.  And  yet  we 
now  tax  the  estate  of  such  person  because  he  has  had  confidence  in  our 
institutions  and  our  citizens.  ...  So  long  as  Massachusetts  and  other 
states  tax  legacies  and  successions  in  this  manner,  we  must  expect  con- 
fusion and  complaint  against  tax  la\vs.  In  my  judgment  confiscation 
rather  than  taxation  fitly  describes  this  practice. 

"It  is  well  known  that  the  banks  and  trust  companies  of  Rhode 
Island  which  has  no  inheritance  tax  law  are  now  the  depositories  of 
large  amounts  of  money  of  non-residents.  If  we  shall  cease  taxing  the 
estates  of  non-resident  decedents  with  reference  to  their  personal  prop- 
erty our  financial  institutions  will  receive  large  amounts  of  deposits 
from  foreigners.  Such  money  in  the  hands  of  banks  and  trust  com- 
panies becomes  a  part  of  the  working  capital  of  our  industries.  To 
secure  its  use  is  wise  action,  and  in  my  judgment  ought  not  to  be 
delayed  ..."  (Proceedings  of  the  Sixth  State  and  Local  Taxation 
Conference  1912,  pp.  299-300.) 

The  states  that  have  statutes  for  the  purpose  of  preventing  double 
taxation  of  intangibles  are :  Arkansas.  Connecticut,  Idaho.  Kentucky, 
Louisiana,  Maryland,  Massachusetts,  Minnesota,  Missouri,  Montana, 
Nebraska,  New  York,  North  Dakota,  Oregon,  Pennsylvania,  South 
Dakota,  Tennessee,  Texas,  Utah,  Virginia,  Washington,  West  Virginia 
and  Wyoming.  (1918.) 

1The  last  revision  of  this  act  in  force  at  this  writing  is  that  of 
February  25.  1919. 

2The  amount  of  the  tax  is  determined  by  taking  the  following  per- 
centage of  the  values  given  opposite : 

Per  Cent  Exceed  Exceeding 

1  $     50,000  $ 

2  150,000  50.000 

3  250,000  150.000 

4  450,000  250.000 
6                750.000  450,000 
8               1,000,000  750,000 

Etc. 


TAXATION  OF  SECURITIES  231 

While  the  Stock  Transfer  Acts  do  not  apply  to  bonds,  brief 
mention  of  their  characteristics  should  at  least  be  made.  The 
New  York  statute,1  the  forerunner  of  these  laws,  requires  that 
all  sales,  or  agreements  to  sell  or  memoranda  of  sales  of  stock 
shall  be  subject  to  a  tax  of  two  cents  for  each  hundred  dollars 
of  the  stock's  face  value  except  where  the  shares  have  no  mone- 
tary value,  when  the  tax  is  at  the  rate  of  two  cents  on  each  share. 
Payment  of  the  tax  is  noted  by  the  affixing  of  an  adhesive 
stamp.  The  transfer  of  a  certificate  without  the  stamp  is 
considered  a  misdemeanor,  and  a  transfer  without  the  payment 
of  the  tax  cannot  be  used  as  a  basis  of  legal  proceeding. 

The  Federal  Stock  Transfer  Tax,  which  is  quite  similar  to 
the  New  York  law,  reads  as  follows: 

"All  sales  or  agreements  to  sell,  or  memoranda  of  sales  or 
deliveries  of  or  transfers  of  legal  title  to  shares  or  certificates  of 
stock  or  of  profits  or  of  interest  in  property  or  accumulations 
in  any  corporation,  or  to  rights  to  subscribe  for  or  to  receive 
such  shares  or  certificates  whether  made  upon  or  shown  by  the 
books  of  the  corporation  or  by  any  assignment  in  blank,  or  by 
any  delivery,  or  by  any  paper  or  agreement  or  memorandum  or 
other  evidence  of  transfer  or  sale,  whether  entitling  the  holder 
in  any  manner  to  the  benefit  of  such  stock,  interest,  or  rights  or 
not,  on  each  $100  of  face  value  or  fraction  thereof  2  cents,  and 
where  such  shares  are  without  par  or  face  value,  the  tax  shall 
be  2  cents  on  the  transfer  or  sale  or  agreement  to  sell  on  each 
share,  unless  the  actual  value  thereof  is  in  excess  of  $100  per 
share,  in  which  case  the  tax  shall  be  2  cents  on  each  $100  of 
actual  value  or  fraction  thereof. ' ' * 

The  Place  of  Taxation  for  the  Holder.3 — Where  should  a 
man  pay  his  taxes  ?  Should  all  taxes  be  paid  where  the  security 
holder  resides?  Shall  the  tax  be  paid  where  the  corporation's 

W.  Y.  Tax  Laics  of  1909,  as  amended,  Sees.  270-280. 

^Federal  Revenue  Act  of  1918. 

"There  is  a  hopeful  sign  in  the  recognition  of  situs  now  coming 
forward  in  income  tax  decisions.  In  a  recent  Massachusetts  case,  "as 
applied  to  income  by  resid.nts  through  non-residents'  trustees,  .  .  .  the 
court  is  urged  to  prevent  the  taxation  of  income  of  a  resident  from 
securities  held  by  a  non-resident  trustee,  the  securities  not  being  taxed 
to  the  trustee  by  the  foreign  state."  The  court  states:  "This  princi1"^ 
of  taxation,  just  itself  and  based  upon  recognition  of  like  rights  of  sister 
states,  and  manifestly  aimed  a<,  the  elimination  of  duplicate  taxation 
upon  the  same  property  in  different  states,  does  not  seem  to  violate  any 
guarantee  of  the  Fourteenth  Amendment  of  the  Federal  Constitution." 
.  .  .  Maguire  vs.  Tax  Commissioner,  120  N.  E.  162. 


232  INVESTMENT  ANALYSIS 

property  is  located  or  in  the  state  in  which  it  is  incorporated? 
If,  under  the  latter  condition,  the  taxes  paid  are  to  be  divided 
between  the  states,  upon  what  basis  should  they  be  apportioned  ? 
Should  a  resident  of  Chicago  owning  a  private  manufacturing 
plant  in  Missouri  not  be  taxed  on  the  plant,  and  the  holder  of  a 
security  bond  of  a  similar  enterprise  be  taxed?  Should  the 
bond  be  taxed  and  the  stock  not,  or  vice  versa  ?  Legislation  and 
judicial  decisions  are  still  in  considerable  confusion  in  trying 
to  find  answers  for  these  questions.  If  securities  are  to  be 
directly  taxed,  the  situs  must  be  determined  before  the  taxation 
of  intangibles  in  the  various  states  can  be  made  equitable.  The 
constitutional  restrictions,  the  eagerness  of  the  state  to  tax  all 
objects  without  an  understanding  of  the  results,  and  the  unwill- 
ingness to  give  up  old  practices  have  been  responsible  for  this 
situation. 

It  is  now  a  recognized  rule  in  the  United  States  that  real 
estate  should  be  exclusively  taxed  where  located.  With  tangible 
personal  property  and  intangible  property  the  determination 
of  situs  is  more  difficult.1  The  Committee  of  the  National  Taxa- 
tion Association  of  1915,  which  made  a  detailed  study  of  the 
decisions  affecting  situs,  has  well  summarized  the  problems 
involved.  This  summary  is  quoted  at  length: 

"1.  Tangible  personal  property  if  permanently  located  is 
taxable  where  located  and  not  elsewhere;  if  not  permanently 
located  elsewhere,  it  is  taxable  at  the  domicile  of  the  owner. 
(Union  Transit  Company  vs.  Kentucky,  199  U.  S.  194;  South- 
ern Pacific  Company  vs.  Kentucky,  222  U.  S.  63.) 

"2.  Intangible  personal  property  is  subject  to  taxation  at 
the  domicile  of  its  owner.  Whether  such  intangible  personal 
property  is  subject  to  taxation  at  the  domicile  of  its  owner  when 
it  has  acquired  an  independent  situs  for  taxation  in  another 
jurisdiction  is  uncertain.  The  current  opinion  seems  to  be  that 
it  is.  The  contrary  view,  however,  has  been  suggested,  and  it 
is  not  impossible  that  the  rule  applicable  to  tangible  personal 
property  may  be  extended  to  intangible  personal  property. 
(Cf.  Hawley  vs.  Maiden,  232  U.  S.  1,  12,  Liverpool,  etc.,  Ins. 
Co.  vs.  Orleans  Assessors,  221  U.  S.  346,  354.)  In  the  cases  in 
which  taxation  of  such  property  in  two  jurisdictions  has  been 

*In  a  recent  case  the  court  decided  that  a  corporation  organized  in 
the  state,  but  having  no  property  in  the  state,  should  he  taxed.  Grand 
Forks  County  vs.  Cream  of  Wheat  Company,  170  M.  W.  863. 


TAXATION  OF  SECURITIES  233 

sustained,  the  property  subject  to  taxation  at  the  domicile  of 
its  owner  has  been  considered  to  be  different  from  that  subject 
to  taxation  in  the  other  jurisdiction,  i.  e.,  in  the  case  of  a  mort- 
gage of  real  estate  the  debt  is  subject  to  taxation  at  the  domicile 
(Kirtland  vs.  Hotchkiss,  100  U.  S.  491)  ;  the  interest  in  real 
estate  where  the  land  lies  (Savings  Society  vs.  Multnomdh 
County,  169  U.  S.  421)  ;  in  the  case  of  shares  of  stock  the  shares 
are  subject  to  taxation  at  the  domicile;  the  corporate  property, 
where  such  property  is  located  or  where  the  corporation  is 
incorporated.  Hawley  vs.  Maiden  supra,  page  9.  Shares  of 
stock  may  be  made  subject  to  taxation  in  the  state  of  incorpora- 
tion— Corry  vs.  Baltimore,  196  U.  S.  466 — whether  they  may  be 
made  subject  to  taxation  both  there  and  at  the  domicile  of  the 
owner,  quaere.  (See  Hawley  vs.  Maiden,  supra.) 

"3.  Intangible  personal  property  may  acquire  a  situs  for 
purposes  of  taxation  independent  of  the  domicile  of  its  owner. 
The  law  upon  this  point  must  be  separately  stated  for  different 
forms  of  intangible  personal  property  .  .  . 

"f.  State  and  municipal  bonds  are  subject  to  taxa- 
tion in  the  jurisdiction  in  which  they  are  permanently 
located.  (See  New  Orleans  vs.  Stempel,  supra,  p.  322. 
Buck  vs.  Beach,  206  U.  S.  392,  407.)  .  .  . 

"h.  Bonds,  being  specialties,  are  subject  to  taxation 
in  the  jurisdiction  in  which  they  are  permanently  located. 
(Holmes,  J.,  in  Selliger  vs.  Kentucky,  213  U.  S.  200, 
204.)  How  far  the  decision  in  State  Tax  on  Foreign 
Held  Bonds,  supra,  as  limited  by  later  decisions  estab- 
lishes the  proposition  that  such  bonds  are  not  subject 
to  taxation  in  the  jurisdiction  in  which  the  debtor  is 
domiciled  is  not  clear.  It  is  possible  that  even  if  an 
ordinary  credit  or  promissory  note  is  subject  to  taxation 
in  the  jurisdiction  in  which  the  debtor  is  domiciled,  a  bond 
— being  considered  the  thing  itself — is  subject  to  a  dif- 
ferent rule.  (See  Blackstone  vs.  Miller,  supra,  p.  205.) 
"i.  Mortgages  are  subject  to  taxation  in  the  jurisdic- 
tion in  which  the  land  lies  on  the  theory  that  the  tax  is 
imposed  upon  the  mortgagee's  interest  in  the  real  estate. 
(Savings  Society  vs.  Multnomah  County,  supra.)  So 
far  as  has  yet  been  decided,  the  note  or  bond  secured  by 
such  mortgage  is  subject  to  the  same  rules  of  taxation  as 
an  unsecured  note  or  bond.  (See  supra  2  and  3,  g  and  h.) 
"j.  Corporate  stock.  Shares  of  stock  in  corporations 
organized  under  state  laws  may  be  given  a  situs  for  the 
purpose  of  taxation  within  the  state  of  incorporation. 
(Corry  vs.  Baltimore,  supra.)  It  is  undecided  whether 


234  INVESTMENT  ANALYSIS 

under  these  circumstances  such  shares  of  stock  may  also 
be  taxed  at  the  domicile  of  the  owner. 

"k.  Shares  of  stock  in  national  banks  are  by  Federal 
statute  subject  to  taxation  only  in  the  state  in  which 
such  banks  are  located."1 

Incidence  of  Taxation  of  Intangibles  (Securities]  ' — The  one 
concern  to  the  security  holder  in  studying  taxation  of  intan- 
gibles is,  who  finally  pays  the  tax?  A  tax  may  be  shifted  to 
another,  though  the  direct  payment  of  the  tax  by  the  security 
holder  makes  it  difficult  for  him  to  appreciate  this.  A  little 
study  of  the  shifting  and  incidence  of  taxation  soon  convinces 
one  of  the  many  possibilities  of  the  shifting  of  a  tax. 

The  tax  upon  the  security  can  be  levied  either  on  the  income 
or  on  the  property  of  the  corporation  or  on  the  principal  of 
the  security  held.  If  the  tax  is  on  income,  the  direct  tax  on 
the  income  of  the  corporation  is  of  as  much  importance  to  the 
security  holder  as  the  tax  on  the  income  from  the  stock  or  bond 
in  his  possession.  If  the  tax  is  a  general  tax  on  all  forms  of 
income,  the  tax  cannot  be  shifted  from  the  individual  share- 
holder or  unit  upon  which  the  tax  is  levied,  as  the  return  from 
all  sources  will  be  affected  alike.  If  the  tax  is  placed  upon  the 
income  of  a  selected  class  of  individuals,  corporations,  or  other 
particular  units,  or  if  a  general  tax  is  unequally  levied,  the  tax 
will  result  in  a  discount  of  the  market  value  of  the  stock.  This 
will  be  a  specific  loss  to  the  individual  who  held  the  stock 
before  the  tax  was  levied.  The  purchaser,  however,  who  buys 
the  stock  after  the  levy  of  the  tax,  will  be  given  the  benefit  of 
the  discount  of  this  tax.  If  the  corporation  deducts  the  tax 
from  the  interest  the  result  is  the  same.* 

If  a  general  property  tax  be  placed  upon  a  particular  kind 
or  group  of  corporations,  and  the  tax  can  be  shifted  to  the 
consumer  of  the  products,  or  by  an  increase  of  rents  or  interest 
charge,  the  result  will  be  the  same  to  the  stockholder,  as  with 


^Proceedings  of  National  Taxation  Association,  1915,  pp.  369-371. 

"What  logically  might  seem  under  this  topic  to  be  the  conclusion  of 
this  chapter — and  it  might  well  be  read  in  conclusion — is  included  here 
to  give  the  reader  a  clearer  conception  of  the  purpose  of  the  chapter. 

»Edwin  R.  A.  Seligman,  Essays  on  Taxation  (8th  ed.  1912),  p.  308. 
A.lso  see  Double  Taxation. 


TAXATION  OF  SECURITIES  235 

the  partial  income  tax.  The  stock  will  sell  at  a  discount  equiva- 
lent to  the  tax.  The  holders,  at  the  time  of  the  imposition  of 
the  tax,  are  the  losers.  If  the  dividends  are  lowered  to  meet 
this  tax,  the  subsequent  purchaser  is  as  well  off,  for  the  lower 
market  value  will  mean  an  equivalent  net  yield. 

The  former  general  practice  of  corporations,  as  far  as  pay- 
ment at  source  is  concerned,  was  to  assume  the  payment  of 

the  bond  tax.     With  the  increase  of  the  Federal  income  taxes. 

^ 

however,  corporations  which  assume  this  tax  are  beginning  to 
limit  the  amount  of  the  tax  that  will  be  assumed.  If  the  cor- 
poration pays  the  normal  2  per  cent  tax  on  the  bonds,  the 
bondholder  then  has  the  right  to  deduct  this  tax  on  the  filing 
of  the  proper  exemption  schedule.  It  has  been  conclusively 
shown,  as  referred  to  elsewhere,  that  where  the  tax  cannot  be 
shifted  in  another  way,  it  will  ultimately  result  in  a  higher 
rate  being  paid  by  the  borrower.  This  has  been  conclusively 
shown  in  mortgage  taxation. 

Exemptions.1 — With  the  constant  changes  in  tax  laws  bear- 
ing upon  securities  and  with  the  adoption  of  income  taxes  with 
their  particular  exemptions,  a  careful  consideration  of  tax 
exempt  securities  has  become  of  more  importance  to  the  investor. 
So  many  technicalities  and  obscure  legal  points  are  involved, 
however,  that  it  is  always  advisable  to  secure  the  advice  of  an 
expert.  For  illustration,  when  the  privilege  of  exchanging  the 
3!/2's  Liberty  Loans  into  the  4's  was  given,  many  exchanges 


*The  state  constitutions  of  twenty-two  states  do  not  permit  of  either 
exempting  or  taxing  securities  at  a  lower  rate  than  other  property. 
In  three  states  the  right  of  exemption  is  doubtful.  The  remaining 
states  have  the  right  to  pass  exemptions  or  lower  rates  under  their  con- 
stitutions. (Investment  Bankers1  Bulletin,  Vol.  I,  Xo.  5,  Aug.  29,  1913.) 
Exemption  of  personal  property  outside  of  state :  Alabama,  California, 
Connecticut,  Indiana.  Louisiana,  Maine,  Missouri.  ISew  Jersey,  Ohio, 
Rhode  Island,  South  Carolina.  Vermont,  and  West  Virginia  exempt 
personal  property  from  taxation  when  the  property  is  permanently 
located  in  another  state  and  taxed  in  that  state.  Exemption  of  bonds : 
Eight  states,  California,  Connecticut,  Colorado,  Massachusetts,  Missis- 
sippi (if  the  rate  does  not  exceed  6  per  cent),  New  Jersey,  Rhode  Island 
and  Wyoming,  exempt  real  estate  bonds  secured  by  real  estate  within 
the  state.  All  bonds  in  Michigan,  Minnesota  (see  Recording  Tax)  and 
Missouri  (specially  enumerated)  are  subject  to  the  special  Debt  Secured 
Tax.  Iowa,  Maryland,  and  Pennsylvania  have  a  classification  for  all 
bonds. 


236  INVESTMENT  ANALYSIS 

which  could  have  been  made  with  profit  by  the  small  purchaser 
of  the  31/2  's  were  not  made  because  of  the  mistaken  notion  that 
the  tax  would  more  than  offset  the  increase  in  interest.  It 
was  the  taxes  applicable  to  the  later  Liberty  Loan  issues  which 
resulted  in  their  greater  depression  in  price  than  the  3^'s.  Of 
course,  had  this  same  original  small  purchaser  of  the  3^'s  pur- 
chased one  of  the  other  issues  at  the  point  of  greatest  deprecia- 
tion, his  advantage  would  have  been  larger.  The  problem  of 
switching  from  tax-exempt  municipals  to  higher  yield  railroads 
involves  the  same  kind  of  problem  and  must  be  studied  in  rela- 
tion to  one's  taxable  income. 

One  of  the  most  illuminating  experiences  showing  the  effect 
of  tax-exemption  privileges  is  in  the  trend  of  the  Liberty  issues 
of  the  United  States  during  1920.  At  no  time  during  the  entire 
period  of  the  downward  movement  of  the  other  Liberty  issues 
which  only  had  partial  exemption  privileges  did  the  3^  per 
Cents,1  wrhich  enjoyed  full  exemptions,  show  a  corresponding 
fall  in  price.  This  issue,  because  of  the  effect  of  the  gradual 
Federal  income  tax  rate,  was  bought  up  by  the  large  investors 
who  placed  the  bonds  in  their  strong  boxes.  As  a  consequence, 
the  large  resales  of  the  other  Liberty  issues  which  depressed  the 
market  did  not  include  the  3x/2  issue.  "With  the  rumor,  how- 
ever, in  May,  1921,  that  the  Federal  income  taxes  were  to  be 
lowered,  the  Liberty  3y2  's  settled  to  new  low  records.  But  this 
is  again  an  illustration  of  the  operation  of  the  same  conditions 
referred  to  above. 

The  bonds  issued  by  the  Federal  Farm  Loan  system  are  also 
privileged  to  exemption  from  the  Federal  income  tax.  With 
these  farm  loan  bonds,  whose  nominal  rate  is  5  per  cent,  selling 
at  a  price  to  yield  4.75,  this  yield  to  an  individual  with  an  in- 
come of  $50,000  would  be  equivalent  to  a  net  return  of  6.88 
per  cent  from  a  bond  whose  income  to  the  individual  was  sub- 
ject to  the  tax. 

The  advantages  to  the  holder  of  municipal  securities  under 
the  exempt  privileges  were  very  quickly  reflected  in  the  in- 
creased market  for  these  securities.  The  reason  for  this  is  seen 


1PThe  3%'s  are  also  exempt  from  all  taxes  with  the  exception  of 
estate  and  inheritance  taxes. 


TAXATION  OF  SECURITIES  237 

in  the  following  table  which  shows  the  income  that  a  bond,  sub- 
ject to  the  Federal  income  tax,  must  yield  to  give  an  income 
equivalent  to  that  of  municipal  bonds  not  subject  to  this  tax : 

Indivi- 
dual's     Yield  of  Municipal  Bonds  Not  Subject  to  Federal  Income  Tax 

Income                                 4%                                4%%  5% 

The  yield  necessary  when  the  income  from  the  bonds 

to  the  holder  is  subject  to  the  tax,  to  yield  the  above 
amounts  on  municipal  tax  exempt  bonds. 

$  10,000                                  4.49                                  5.06  5.62 

50,000                                  5.80                                  6.52  7.25 

100,000                                  9.09                                10.23  11.36 

500,000                                13.79                                15.52  17.24 

"With  this  variation  determined  by  the  amount  of  the  indi- 
vidual's  income,  the  ultimate  influence  on  the  price  of  the 
securities  can  only  be  approximated,  unless  the  conditions  of  the 
particular  income  are  known. 

The  original  act  of  1913  made  a  further  provision  for  the 
so-called  normal  tax  of  1  per  cent  which  could  be  paid  at  its 
source.  This  rate  was  increased  to  2  per  cent  under  the  act  of 
1918.  Under  this  "tax-free-covenant,"  certificates  are  required 
with  the  presentation  of  coupons  indicating  that  the  tax  has 
been  paid.  The  effect  of  the  payment  or  non-payment,  theo- 
retically at  least,  has  a  corresponding  effect  on  the  price  of  the 
bond. 

To  illustrate,  first  assume  that  a  5  per  cent  return  is  de- 
manded on  a  $5,000  bond  and  the  corporation  has  not  paid  the 
full  2  per  cent  tax  demanded;  what  would  be  the  effect  on  the 
price  of  the  bond?  The  prospective  purchaser  of  the  bond 
would  realize  first  that  the  tax  on  the  $250  annual  income  at  2 
per  cent  will  be  $5.00  or  that  the  bond  will  yield  an  income  of 
$245  if  he  has  to  pay  the  tax.  If  he  is  unwilling  to  do  this  it  is 
necessary  to  secure  the  bond  at  a  price  which  will  yield  him  the 
5  per  cent  and  reimburse  him  for  the  amount  paid  out  in  taxes 
on  his  income.  This  price  would  be  found  by  finding  what  sum 
at  5  per  cent  is  necessary  to  give  $245.  On  a  $1,000  bond  this 
return  would  be  $49  for  ttfe  year.  Then  49  -r-  .05  =  980,  the 
price  at  which  the  purchaser  would  have  to  buy  the  bond  if  it  is 


238  INVESTMENT  ANALYSIS 

to  yield  him  a  net  5  per  cent.  The  total  yield  at  a  price  of  980 
for  the  bond  would  be  5.10  but  after  deducting  .10,  the  amount 
of  the  tax,  the  net  amount  to  the  holder  would  be  5  per  cent. 
If  the  corporation  paid  the  tax  it  would  have  to  pay  the  .10  on 
this  bond,  which  added  to  the  5  per  cent  paid  the  investor 
would  be  5.10,  the  price  which  it  must  pay  for  its  money.1 

Capital  stock,  when  held  by  residents  in  the  state  in  which 
the  corporation  is  incorporated,  is  in  a  few  states  tax-exempt. 
These  securities  have  been  advertised  by  bankers  as  the  most 
desirable  purchases  for  residents  in  that  state.  If  this  is  an 
actual  net-advantage  to  the  resident-purchaser,  the  argument  is 
for  the  purchase.  The  arguments  advanced  for  these  non- 
taxable  securities  are  not  always  discriminating  as  to  the  char- 
acter of  the  securities  offered.  Does  the  larger  net-yield  actually 
arise  from  the  advantage  that  the  particular  security  possesses 
over  other  securities  in  the  same  market,  or  is  it  due  to  a  differ- 
ence in  the  inherent  values  of  the  corporation  itself?  When  a 
market  is  once  cognizant  of  an  advantage  or  disadvantage,  it 
will  always  level  up  these  differences  in  securities  of  equal 
grade,  though  experience  has  shown  that  with  purely  local 
issues,  especially  the  smaller  ones,  the  advantage  of  tax-exemp- 
tion may  continue  for  several  years  before  the  market  price  has 
fully  recognized  this  influence.  On  the  other  hand,  the  latter 
qualification  raises  the  whole  argument  of  the  relative  safety 
(other  things  of  course  being  equal)  of  the  small  and  the  large 
corporate  issues  as  purchases.  The  requirements  of  the  indi- 
vidual purchaser  must  determine  this. 

Where  the  securities  are  of  equal  safety,  the  comparison 
between  these  tax-exempt  securities  of  corporations  and  tax- 
exempt  state  and  municipal  bonds  should  not  be  overlooked. 
The  former  are  subject  to  the  Federal  income  tax,  while  the 
latter  are  not,  a  condition  which  will  give  some  of  the  munici- 
pal bonds  the  advantage  of  a  higher  net  yield.  Again  the  ten- 
dency of  the  market  prices  in  the  long  run  is  always  to  tend  to 


'Roy  C.  Osgood,  The  Effects  of  Taxation  on  Securities,  Annals 
Amer.  Acad.  of  Pol.  $  Soc.  Sci,  vol.  Ixxxviii,  p.  165.  No  reference  has 
been  made  to  the  Excess  Profits  Tax  (which  applies  to  the  income  of 
corporations,  or  to  Preferred  Stock)  as  the  latter  issues  are  not  pri- 
marily discussed  in  this  volume. 


TAXATION  OF  SECURITIES  239 

level  up  according  to  their  prospective  advantages  or  disadvan- 
tages, so  that  the  purchaser  will  pay  for  the  privileges  accru- 
ing to  him. 

Exemptions  from  taxes  on  stocks  and  bonds  have  been  made 
by  a  few  states  to  encourage  industry  to  locate  within  the  states, 
though  the  majority  of  exemptions  are  for  the  avoidance  of 
duplication  in  taxation.  The  majority  of  the  jurisdictions,  how- 
ever, tax  the  holder  of  corporate  securities  without  regard  to 
their  location.1  This  frequently  results  in  unjustified  double 
taxation. 

Some  states,  as  noted  under  the  low  rate  plan,  effect  a  com- 
promise by  allowing  a  low  rate  in  the  form  of  a  single  record- 
ing tax  or  a  low  annual  rate  only  applicable  to  intangibles. 
Judicial  decisions  in  still  another  group  of  states  have  required 
the  state  to  make  exemptions.  The  change  in  the  courts'  atti- 
tude on  a  number  of  the  important  points  of  their  decisions 
has  often  made  these  decisions  uncertain  criteria.2  With  the 
exception  of  the  efforts  to  correct  unjust  duplicate  taxation, 
direct  exemptions  for  corporation  securities  are  on  the  decrease. 

The  difficulty  of  the  problem  of  taxing  securities  of  foreign 
corporations  held  by  residents  continues,  because  of  the  inability 
to  agree  upon  the  situs.  But  where  exemptions  of  the  securi- 
ties of  corporations  of  other  states  are  made,  there  is  consid- 
erable difference  in  procedure  among  the  states.  A  few  states 
exempt  investors'  share-holdings  in  foreign  corporations  when 
they  are  taxed  in  the  state  in  which  the  company  is  organized.3 
Massachusetts  under  its  old  law,  existing  since  1836,  made  a 
distinction  between  domestic  and  foreign  shareholders,  exempt- 
ing the  former  and  taxing  the  holders  of  foreign  shares.  Real 
estate  mortgages  and  the  capital  stock  of  manufacturing  cor- 
porations are  the  securities  which  are  most  commonly  exempted. 


Exemptions  must  be  studied  in  close  conjunction  with  situs  and 
Double  Taxation.  Also  see  excerpts  from  state  constitutions  and  stat- 
utes for  exemptions. 

2A  study  of  the  Lousiana  cases  is  particularly  instructive  in  this 
connection. 

"This  general  rule  is  accepted  either  by  statute  or  decision  in  Cali- 
fornia, Connecticut,  Louisiana,  New  Hampshire,  New  Jersey,  New  York, 
Rhode  Island  and  Vermont.  (See  also  footnote  on  Real  Estate  Mort- 
gages.) 


240  INVESTMENT  ANALYSIS 

As  corporate  loans  are  not  often  directly  taxed,  the  problems 
of  special  exemptions  are,  accordingly,  less  frequent.  When 
direct  taxation  of  both  the  corporation  and  its  bonds  is  prac- 
ticed, the  subject  is  controversial,  and  Professor  Seligman  main- 
tains that  "so  soon  as  the  taxation  of  corporate  loans  becomes 
as  general  as  is  now,  the  taxation  of  corporate  stock,  we  shall 
be  confronted  with  precisely  the  same  difficulties."  (This 
does  not,  of  course,  refer  to  the  income  tax.) 

The  exemption  of  municipals  is  more  consequential  than  that 
of  any  other  class  of  securities,  and  is  especially  important 
since  the  adoption  of  the  income  taxes.  This  includes  the  bonds 
of  the  United  States,  except  those  previously  specified  as  exempt, 
territories,  insular  possessions,  municipalities  of  territories  and 
states,  and  all  subdivisions  of  the  state  where  so  designated  by 
the  state  constitution  or  statute.  The  exemption  of  territorial 
issues  has  been  debated.  Attorney  Frederick  N.  Judson  draws 
the  conclusion  that  "it  was  contended  that  Congress  had  no 
power  to  declare  this  exemption.  But  the  Circuit  Court  of 
Appeals  (6th  Cir.)  held,  .  .  .  'That  where  Congress  lawfully 
directs  the  issue  of  evidence  of  indebtedness  in  the  exercise  of 
any  power  derived  by  it  from  the  Constitution  .  .  .  such  evi- 
dence of  debt  are  exempt  from  state  taxation,  or  at  least  may 
be  exempted  therefrom,  if  Congress  sees  fit  to  give  them  this 
quality.'"' 

In  the  states  which  allow  tax  exemption  of  their  own  issues 
and  those  of  their  subdivisions,  the  outstanding  factor  is  the 
recent  date  of  the  extension  of  this  privilege.  Only  five  states 
out  of  the  list  given  below  allow  entire  exemption  of  all  issues.' 


''Edwin  R.  A.  Seligman,  Essays  on  Taxation  (1912),  p.  308. 

Frederick  N.  Judson,  A  Treatise  on  the  Power  of  Taxation  (1917), 
p.  17.  See  other  leading  cases  cited  in  this  chapter.  McCulloch  vs. 
Maryland  (4  Wheaton  316,  4  L.  Ed.  579)  ;  Osborn  vs.  United  States  (9 
Wheaton  738,  6  L.  Ed.  204)  :  Weston  vs.  Charleston  (2  Peters,  450,  7 
L.  Ed.  481)  ;  Grether  vs.  Wright  (23  C.  C.  A.  498.  75  Fed.  742,  1896)  ; 
Farmers  &  M.  Savings  Bank  vs.  Minnesota  (232  U.  S.  516,  58  L.  Ed. 
706;  1914),  etc. 

sOf  the  Civil  Obligations  all  bonds  or  certificates  issued  prior  to 
the  European  war  of  1914  are  "exempt  from  the  payment  of  taxes  or 
duties  of  the  United  States  as  well  as  from  taxation  in  any  form  by 
or  under  state,  municipal  or  local  authority."  (See  also  2  Peters  450, 
7  L.  Ed.  481.)  They  are  not  exempt  from  Federal  estate  taxes.  The 
principal  of  all  obligations  issued  during  the  War  is  exempt,  as  well  as 


TAXATION  OF  SECURITIES  241 

If  the  rate  of  increase  in  exemptions  of  the  last  ten  years  con- 
tinues, a  very  large  share  of  all  issues  outstanding  will  be  ex- 
empted in  another  decade.  Consequently,  as  municipals  bonds 
are  not  subject  to  the  Federal  Income  Tax,  it  will  result  in  a 
relative  lowering  of  the  rates  of  these  issues  as  compared  to 
those  of  the  best  secured  private  corporations.  While  first  the 
advocacy  and  then  the  adoption  of  the  income  taxation  have 
hastened  this  action,  already  considerable  agitation  is  being 
made  against  any  form  of  exemption. 

the  income  from  the  First  Liberty  Loan  3%'s.  On  all  other  war  issues 
the  income  from  an  aggregate  of  $5,000  is  exempt  from  taxes.  Other 
special  exemptions  are  allowed  in  each  issue  for  which  it  is  necessary 
to  consult  the  statute. 

The  insular,  territorial,  and  territorial  municipal  bonds  are  also 
exempted,  though  there  has  been  considerable  contention  over  the  latter. 
(Grether  vs.  Wright,  23  C.  C.  A.  498,  75  Fed.  742,  1896.) 

Federal  Stock  Land   Banks  and  Federal  Land  Banks  bonds  have 
been  exempted  by  special  act  of  Congress. 

Of  the  states,  the  following  exempt  practically  all  of  the  issues  of 
the  state  and  its  divisions  (The  date  following  indicates  the  date  from 
which  the  exempt' on  applied.  Because  of  limit  of  space,  statutes  are 
not  given)  :  Alabama  (1911)  ;  Arizona  (1912,  and  by  decision  of  terri- 
torial and  territorial  municipal  issues)  ;  California  (1902)  ;  Connecticut 
(1917)  ;  Delaware  (see  Chronical  Jan.  29,  1919,  p.  108)  ;  Georgia  (last 
decision  1907)  ;  Indiana  (1903)  ;  Iowa  (1909)  ;  Kansas  (1909)  ;  Ken- 
tucky (1915)  ;  Louisiana  (see  Chronicle,  June  29,  1919,  p.  147)  ;  Maine 
(1909)  ;  Maryland  (1914)  ;  Massachusetts  (1908)  ;  Michigan  (1909)  ; 
Minnesota  (1911)  ;  New  Jersey  (1893)  ;  New  Mexico  (same  as  Arizona)  ; 
New  York  (1908)  ;  Utah  (Special  ruling,  no  special  statute)  ;  Washing- 
ton (1907)  ;  Wisconsin  (1911)  ;  Wyoming  (1905). 


BOOK  II 
CORPORATION  BONDS 


CHAPTER  XIV 

RAILROAD   BONDS:    PHYSICAL   FACTORS,   TRAFFIC 
STATISTICS,  AND  REGULATIONS 

Traffic  Determinates.1 — The  character  of  the  traffic  of  a  rail- 
road is  determined  largely  by  its  geographical  location.  In  the 
United  States  this  has  been  peculiarly  true  because  of  the  great 
expanse  of  territory,  which  has  meant  both  a  wide  range  in 
the  character  of  traffic  and  a  considerable  percentage  of  long 
hauls.  It  is  the  latter  peculiarity  which  makes  any  financial 
comparison  with  the  European  railroads  almost  impossible. 
The  first  requirement,  therefore,  in  any  analysis  of  railroad 
securities  is  a  careful  examination  of  a  railroad's  location,  the 
character  and  the  permanency  of  the  resources,  the  existing  and 
potential  possibilities  of  production  in  the  territory,  and  the 
location  and  character  of  its  terminal  facilities.  It  is  to  an 
analysis  of  these  physical  factors  that  this  chapter  is  devoted. 
Earnings,  maintenance,  operating  expense,  etc.,  which  must  be 
studied  in  close  conjunction  with  this  problem  are  treated  in 
the  following  chapter. 

If  one  or  more  large  terminal  cities  are  tapped,  they  provide 
both  a  direct  market  and  the  opportunity  of  reshipments  for 
an  exchange  of  long  haul  traffic  with  other  railroads.  The 
Chicago,  Peoria,  and  St.  Louis,  one  of  the  old  railroads  of  the 
Middle  West,  is  a  striking  illustration  of  a  railroad  which  has 
been  handicapped,  among  other  things,  by  the  character  of  its 
two  terminal  cities.  These  two  cities  have  very  little  to  ex- 
change with  each  other.  Also  a  railroad  which  does  not  take 
a  considerable  ratio  of  its  traffic  from  one  end  of  the  line  to,  or 
nearly  to  the  market  at  the  other  end  of  the  line,  is  necessarily 

*The  reader  should  hold  in  mind  in  the  reading  of  this  chapter  that 
the  author  has  not  attempted  to  cover  the  factors  entering  into  earn- 
ings, operating  expenses,  maintenance,  etc.,  in  this  chapter.  These  are 
analyzed  in  Chapter  xvi.  The  first  part  of  this  chapter  is  entirely 
devoted  to  the  physical  aspects  of  the  railroad. 

245 


246  INVESTMENT  ANALYSIS 

a  failure.  This  road  also  has  the  disadvantage  of  heavy  grades. 
The  Wabash1  railroad  has  suffered  losses  in  traffic  because  its 
eastern  terminus  is  located  in  Buffalo  instead  of  some  Atlantic 
seaboard  city.  The  Western  Maryland  Kailway  which  was 
deprived  of  the  transhipment  from  the  Coal  and  Coke  Railway 
when  the  latter  was  purchased  by  the  Baltimore  and  Ohio  Rail- 
road and  the  Toledo,  St.  Louis  and  Western  are  also  illustra- 
tions of  systems  more  or  less  "bottled  up"  so  far  as  securing 
transhipment  is  concerned.  Both  of  these  systems  are  conse- 
quently largely  dependent  upon  local  traffic.2 

For  a  comparative  analysis,  a  thorough  understanding  of 
the  amount  and  sources  of  traffic,  and  the  physical  influences 
upon  it  is  imperative.  It  is  not  until  these  conditions  are  un- 
derstood that  one  escapes  the  danger  of  making  misleading 
comparisons.  Comparisons  of  companies  are  of  inestimable 
worth  in  obtaining  a  correct  idea  of  railway  properties,  but 
unless  the  bases  of  these  comparisons  are  sound,  the  subsequent 
comparisons  based  upon  them  are  futile. 

Land  contours  have  often  determined  the  survey  of  a  rail- 
road's mileage.  For  example,  a  very  considerable  part  of  the 
Atchison's  right  of  way  through  the  western  mountain  range 
follows  an  old  buffalo  trail,  which  these  beasts  of  the  prairie 
selected  as  the  easiest  trail  across  the  mountains.8  In  the  major 
part  of  its  mileage  between  Cheyenne  and  Ogden,  the  Union 
Pacific  possesses  a  decided  operating  advantage  over  the  Denver 
and  Rio  Grande,  the  greater  part  of  whose  mileage  is  over 
higher  mountain  levels.  The  New  York  Central  Lines  with 
practically  a  "water-level-route"  from  New  York  to  Chicago 
have  always  had  a  decided  operating  advantage  over  the  Penn- 
sylvania, and  Baltimore  and  Ohio  railroads,  which  cross  the 

^Interstate  Commerce  Commission  Reports,  vol.  xlviil.  The  Wabash 
Terminal  Investigation  (December  17.  1917),  pp.  96-200.  The  entire 
report  rather  than  the  specific  reference  is  given  here  because  the  whole 
episode  is  needed  to  obtain  a  correct  understanding  of  the  case. 

*/.  C.  C.  Reports,  vol.  xliv.  in  Re  Pere  Marquette  Railroad  Company 
and  Cincinnati  Hamilton  and  Dayton  Railway  Company  (March  13, 
1917),  pp.  1-223.  What  has  been  said  of  the  previous  reference  also 
applies  here. 

'Numerous  other  illustrations  of  a  similar  character  are  to  be  found 
in  Clark's  American  Highways. 


RAILROAD  BONDS  247 

Allegheny  Mountains.  Engineering  skill  is  surmounting  many 
topographical  obstacles,  and  effecting  lower  operating  costs, 
though  these  advantages  are  normally  procured  only  by  larger 
fixed  investments. 

But  even  more  emphasis  should  be  placed  upon  the  advan- 
tage of  low  grades.  Very  few  people  realize  that  with  each 
additional  one  per  cent  grade  (52  foot  rise  per  mile)  the 
possible  train  load  is  cut  in  two.  The  roads  which  have  been 
the  most  successful  are,  practically  without  exception,  those 
which  either  held  originally  the  lowest  grades  or  which  have 
since  spent  large  sums  to  attain  them. 

Neither  is  it  any  mere  accident  that  the  great  majority  of 
the  railroads  in  the  United  States  run  in  an  easterly  and  west- 
erly direction.  The  large  industrial  and  commercial  ports  of 
the  eastern  and  western  states  which  originally  established 
markets  for  the  mineral  and  agricultural  products  of  the  in- 
terior, created  this  longitudinal  movement  of  traffic  which  still 
continues.  However,  with  the  recent  establishment  of  such 
industrial  centers  as  Birmingham,  South  Chicago,  and  Gary, 
an  increasing  amount  of  traffic  has  been  moving  north  and 
south.  It  is  not  unlikely  that  this  newer  movement  of  traffic 
will  in  time  fully  come  into  its  own  and  fulfill  the  prediction 
made  for  it  ten  to  fifteen  years  ago.  As  far  as  the  Southwest, 
as  distinct  from  the  "Old  South"  east  of  the  Mississippi,  is 
concerned,  there  are  at  the  present  time  too  many  railroads, 
i.  e.,  transportation  facilities  have  increased  faster  than  traffic, 
though  this  territory  is  rapidly  developing  up  to  its  railroad 
capacity.  The  difficulties  experienced  by  the  Rock  Island  be- 
tween 1902  and  1915  were  due  partly  to  the  result  of  a  lack 
of  traffic1  on  its  mileage  west  of  the  Missouri  River.  Every 
other  road  in  the  Southwest — except  the  Atchison  and  South- 

^Railroad  Age  Gazette,  vol.  Iviii,  No.  15  (April  9,  1915),  pp.  774-776. 
Also  see  other  editorials  of  this  same  year.  It  should,  however,  be 
noted  that  in  addition  to  the  above  conditions  mentioned  other  roads 
were  physically  in  better  condition  and  also  had  better  terminals  and 
connections.  The  underlying  trouble  with  the  Rock  Island  prior  to  its 
receivership  was  that  it  continued  the  policies  established  under  the 
Cable  management  of  not  modernizing  its  plant.  While  roads  like  the 
Northwestern  were  cutting  down  grades  and  improving  their  road-beds, 
the  Rock  Island  made  few  improvements. 


248  INVESTMENT  ANALYSIS 

era  Pacific,  which  must  not  be  considered  in  this  group,  as  they 
are  not  governed  by  these  more  local  influences — has  suffered 
from  a  shortage  of  traffic,  i.  e.,  relative  to  systems  in  eastern 
territory. 

The  "promoter  viewpoint,"  as  well  as  that  of  the  general 
market  in  1900-1902,  concerning  the  future  development  of  this 
territory  was  overly  optimistic.  The  general  opinion  in  1902 
was  that  the  grain  movement  east  and  the  commodity  move- 
ment west,  which  had  made  paying  roads  of  the  Chicago,  Mil- 
waukee &  St.  Paul,  the  Northwestern,  and  the  Chicago,  Bur- 
lington &  Quincy,  could  be  partially  diverted  to  the  gulf  ports. 
Up  to  date  the  diversion  of  this  traffic  to  these  ports  has  fallen 
far  short  of  original  estimates,  as  it  has  continued  largely  in 
its  old  channels.  This  emphasizes  the  fundamental  importance, 
in  the  consideration  of  any  railroad,  of  determining  whether 
the  territory  through  which  the  railroad  passes  is  only  in  the 
process  of  development  or  has  been  long  established,  whether 
all  of  its  traffic  is  seasonal,  and  whether  there  is  danger  of  its 
exhaustion.  The  shorter  the  railroad  mileage  or  the  more 
dependent  it  is  on  the  traffic  of  one  product,1  the  relatively  more 
important  it  is  to  have  a  favorable  answer  to  these  questions. 
The  longer  the  mileage,  the  less  is  the  risk  of  its  dependence  on 
one  commodity,  as  in  the  case  of  the  coal  roads. 

Fertility  and  climate,  especially  rainfall,  which  is  the  result 
of  geographic  influences,  are  the  physical  factors  that  fix  the 
limitations  of  agricultural  production.  As  density  of  popula- 
tion can  only  increase  to  the  production  capacity  of  a  given 
area,  the  amount  of  traffic  which  can  be  created  in  this  area  is 
determined  by  the  productive  capacity  and  the  rapidity  with 
which  the  given  territory  is  developed.  Likewise,  productivity 
of  timber  and  mining  areas  determines  the  extent  to  which  the 
earnings  of  railroads  tapping  these  areas  may  be  developed. 
When  a  natural  resource,  as  the  timber  of  a  locality,  is  nearing 
depletion  or  has  been  exhausted,  other  sources  of  traffic  must 
be  developed  to  offset  it.  If  this  has  not  been  possible,  the  rail- 

'An  occasional  exception  exists,  such  as  the  sudden  development  of 
traffic  on  the  Texas  and  Pacific  Railway  due  to  the  opening  up  of  the 
Burkburnnett  oil  fields. 


RAILROAD  BONDS  249 

road  dependent  upon  this  traffic  must  seriously  suffer.  Both 
the  Ann  Arbor  and  Pere  Marquette,1  for  example,  have  had 
unfortunate  experiences  since  the  exhaustion  of  the  large  com- 
mercial timber  supply  of  northern  Michigan. 

If  the  United  States  or  any  particular  group  of  states  should 
undertake  an  extensive  expansion  of  the  inland  waterway 
systems,  it  might  prove  a  serious  competition  to  certain  rail- 
ways. As  the  heavier  and  cheaper  products,  where  possible, 
are  usually  carried  by  water,  the  roads  which  are  the  heaviest 
carriers  of  bulky  commodities  in  the  locality  of  this  competi- 
tion would  suffer  most.  But  it  is  more  than  likely  that  with 
the  development  of  these  areas,  this  lost  traffic  would  be  more 
than  replaced  with  high  grade  commodities,  the  carriage  of 
which  would  be  left  to  the  railroads.  Except  for  the  Great 
Lakes  traffic,  a  very  small  proportion  of  the  domestic  traffic  in 
the  United  States  has  been  transported  by  water,  even  the 
major  portion  of  the  bulky  commodities  being  transported  by 
railroads.  This  is  indicated  by  the  fact  that  mineral  products 
furnish  55  per  cent  of  the  total  rail  traffic. 

Mileage. — A  long  mileage  usually  gives  a  railroad  both  the 
long  haul  and  the  diversity  of  traffic  which  increases  the  sta- 
bility of  its  earning  power.  The  length  of  mileage  is  also,  as 
in  all  railroad  statistics,  relative,  and  must  be  studied  not  as 
an  isolated  factor,  but  in  conjunction  with  the  territory  tra- 
versed, and  the  amount,  character,  and  density  of  traffic.  For 
example,  a  few  years  ago,  the  Gulf  and  Ship  Island  Railroad, 
which  was  solely  dependent  upon  the  timber  industry,  found 
itself  in  strained  circumstances  with  the  slump  of  the  lumber 
market,  while  the  St.  Louis  and  Southwestern  which  has  a  part 
of  its  mileage  in  this  territory,  scarcely  felt  the  strain,  as  lum- 
ber constituted  only  a  small  part  of  its  large  and  diversified 
traffic.2 

Extra  main  line  trackage  in  a  railroad  system  indicates 
increased  utilization  of  the  system.  Railroad  engineers  estimate 
that  the  carrying  capacity  of  a  railroad  is  increased  by  double 

1I.  C.  C.  Reports,  vol.  xliv  (Pere  Marquette  Case). 

2John  Moody,  How  to  Analyze  Railroad  Reports  (1912),  p.  43. 


250  INVESTMENT  ANALYSIS 

tracking  from  2,y2  to  5  times.     This  large  variation  is  due  to 
the  line  of  business  handled  and  speed  of  trains.     Consider- 
able difference,  for  example,  will  result  if  a  number  of  varying 
speeds  for  trains  are  used,  and  likewise  each  additional  pas- 
senger train  on  a  busy  line  makes  a  heavy  inroad  into  the 
road's  freight  carrying  capacity.     Individual  rules  for  study- 
ing the  effect  of  extra  trackage,  consequently,  must  be  estab- 
lished for  each  system.     These  can  be  obtained  from  a  com- 
parative  study   of  the   railroad's  reports  over  several  years. 
For   example,   railroads  with  single   trackage  have   shown   as 
great  a  density  in  traffic  as  systems  with  an  entire  mileage 
double  tracked.     For  general  comparative  purposes  the  meas- 
urement of  railroad  traffic  on  the  basis  of  the  single  track, 
with   an    approximation    of   increased    density    for   additional 
trackage,   would  be   more   accurate  than  a   straight   measure- 
ment   of    total    trackage.      The    financial    statistician    of    the 
banking  house  which  underwrites  railroad  securities,  must,  of 
course,  make  these  computations  with  even  greater  accuracy. 
He  must  establish  his  rule  for  each  individual  system  after  a 
consideration  of  the  effect  of  the  character  of  the  traffic,  the 
ratio  of  short  and  long  hauls,  origination  of  business,  and  the 
density  of  traffic.    He  or  his  advisers  should  also  have  detailed 
maps  of  profiles,  grades,  etc.,  which  here  are  all  essential  for  an 
accurate  analysis.  Advisers,  here,  refer  to  engineers,  upon  whom 
the  banker  practically  always  depends  for  these  latter  details. 
Formerly  the  weight  of  rails  was  an  important  consideration, 
but  the  rapidly  increasing  adoption  of  heavy  equipment1  has 
forced  the  general  adoption  of  heavy  rails  by  all  the  important 
trunk-line  systems.     The  exception  will  be  found  in  the  very 
short  road  or  in  branches  of  trunk-line  systems,  which  do  not 
need  the  heavier  rails  because  of  the  lighter  traffic.     The  same 
conditions  would  also  apply  in  bridge  construction,  grades,  etc. 
Equipment. — As  cars  and  engines  are  the  movable  equip- 
ment that  make  the  operation  of  the  railroad  possible,  a  con- 
sideration of  their  condition  is  of  the  utmost  importance.    Every 

'The  Chespeake  and  Ohio  Railway  has  had  the  unique  experience 
of  being  forced  to  keep  down  the  size  of  its  equipment  on  account  of  its 
tunnels. 


EAILROAD  BONDS  251 

railroad  report  should  show  the  exact  condition  and  service 
ability  of  the  equipment,  as  far  as  a  detailed  financial  state- 
ment can,  for  the  lack  of  a  proper  maintenance  of  equipment, 
may  necessitate  a  sudden  and  large  expenditure  that  may 
prove  embarrassing.  For  example,  when  the  Rock  Island  Com- 
pany obtained  control  of  the  Chicago  &  Alton  Railroad  (control 
which  was  later  given  up)  it  was  found  necessary  to  secure 
at  once  a  large  amount  of  equipment,  though  both  roads  were 
hard  pressed  for  funds.  A  complete  report  should  show  the 
number,  age,  size,  character  of  construction,  and  capacity  of 
cars,  and  weight  and  tractive  power  of  engines,  together  with  a 
list  of  current  additions  and  retirements.  As  the  change  from 
wooden  to  steel  cars  is  still  under  way,  and  the  capacity  and 
durability  of  cars,  as  well  as  the  tractive  power  of  engines, 
have  so  greatly  increased,  the  enumeration  of  equipment  entails 
more  than  a  mere  classification.  Comparison  of  equipment  on 
a  per  mileage  basis,  a  method  often  used,  may  be  entirely  mis- 
leading (although  such  a  comparison  may  safely  and  with 
benefit  be  made  by  the  technical  statistician)  unless  considered 
in  connection  with  various  other  factors.  For  ordinary  pur- 
poses, a  comparison  of  the  yearly  growth  and  character  of  the 
equipment  will  reveal  sufficient  information  as  to  both  its  pres- 
ent state  and  the  tendencies  in  the  policies  of  management,  in 
regard  to  equipment. 

A  separation  should  also  be  made  between  equipment  owned 
without  encumbrance  and  equipment  owned  subject  to  the 
claims  of  equipment  bonds  or  trust  certificates.  The  latter 
method  of  controlling  equipment  is  common  and  necessary,  as  it 
is  essential  to  know  the  property  in  fee  behind  the  general 
claims  of  the  company.  This  problem  is  discussed  in  a  subse- 
quent chapter. 

A  complete  physical  equipment  report  will  give  a  good  deal 
of  valuable  information  concerning  the  policy  of  the  operating 
management  though  these  facts  cannot  be  procured  from  the 
annual  reports  of  railroads.  A  comparison  of  the  number  of 
either  passenger  or  freight  cars  with  the  density  of  traffic  and 
the  earnings  will  show  how  effectively  equipment  is  being  util- 
ized. The  class  of  rolling  stock,  together  with  the  character 


252  INVESTMENT  ANALYSIS 

of  traffic,  will  assist  in  determining  the  number  of  empty  cars 
that  must  be  returned  in  the  back  haul,  a  factor  directly  affect- 
ing operating  costs.  In  this  same  connection  car  intercharge 
becomes  so  important  that  the  ' '  hire-of -equipment  balance ' '  may 
be  as  important  as  the  railroads  own  facilities. 

The  efficiency  in  operation  is  also  determined  by  the  number 
and  kind  of  cars  that  can  be  accumulated  at  any  point  along 
the  line  to  meet  the  demand  of  a  particular  kind  of  traffic. 
Efficiency  also  might  be  affected,  by  the  capacity  of  the  cars — 
for  example,  by  the  use  of  the  old  small  wooden  coal  car  instead 
of  the  large  steel  car;  but  greater  standardization  has  almost 
entirely  eliminated  the  necessity  of  considering  this  factor, 
which  formerly  could  not  be  omitted.  But  as  stated  above,  these 
facts  are  not  available  in  the  public  reports. 

Rolling  stock  equipment  depreciates  so  rapidly  that  its  con- 
dition readily  reflects  the  thoroughness  of  a  railroad's  manage- 
ment. Maintenance  of  equipment,  which  is  an  ever-present 
problem,  is  one  of  the  items  which  can  be  neglected  temporarily, 
at  least,  under  pressure.  The  Rock  Island  and  Missouri  Pacific 
systems,  prior  to  their  last  receiverships,  made  such  large  sacri- 
fices in  their  maintenance  accounts  that  the  problem  of  rehabili- 
tation following  receivership  was  extraordinary.  If  the  policy 
of  keeping  the  equipment  in  a  merely  usable  condition  is  fol- 
lowed through  a  long  continued  pressure  of  financial  embarrass- 
ment, however,  a  general  impaired  efficiency  will  soon  show 
itself. 

The  advantage  of  the  steel  freight  cars  in  greater  durability 
and  lower  maintenance  is  partly  offset  by  the  greater  tractive 
power  needed  for  hauling  the  heavier  cars,  unless  the  carload 
has  been  more  than  proportionately  increased  and  the  "emp- 
ties" in  the  back  haul  have  been  reduced  to  a  minimum.  In 
steel  passenger  cars,  where  the  weight  of  the  passenger  is  a 
small  percentage  of  the  weight  of  the  car,  full  capacity  is  neces- 
sary to  insure  profits.  "What  is  probably  the  most  accurate 
measurement  of  the  railroad's  equipment  efficiency  is  the  trac- 
tive power  of  its  locomotive,  i.  e.,  the  pulling  force  of  the  engine.1 


*M.  L.  Byers,  Economics  of  Railway  Operation  (1908).  This  author 
will  give  the  reader  an  appreciation  of  the  technical  problems  of  rail- 
road operation  as  related  to  financing. 


RAILROAD  BONDS  253 

As  applied  to  each  railroad  system,  the  measurement  should  be 
made  on  the  basis  of  both  tractive  power  and  adaptability  of 
the  engine  to  the  particular  needs  of  the  system.  Where,  for 
example,  very  dense  traffic  exists,  the  Mallet  type  of  engine  is 
the  most  economical.  The  Mallet  engine,  on  the  other  hand,  is 
an  expensive  luxury  where  freight  traffic  density  is  light. 

Passenger  and  Freight  Traffic. — The  major  part  of  the  in- 
come of  the  railroads  in  the  United  States  is  from  freight. 
Passenger  traffic,  being  limited  in  amount  and  requiring  more 
costly  equipment,  has  never  been  a  very  profitable  source  of 
income.  There  are  a  few  notable  exceptions  to  this  generality, 
such  as  the  New  York,  New  Haven  and  Hartford,  which  has  a 
considerable  revenue  from  its  suburban  traffic,  but  this  is  the 
exception  and  not  the  rule  for  railroads  in  the  United  States. 
The  Long  Island  at  the  one  extreme  has  led  all  railroads  in  the 
country  in  its  proportion  of  passenger  traffic  income,  its  total 
income  from  this  source  in  some  years  being  70  per  cent.  At 
the  other  extreme  we  find  the  Pittsburgh  and  Lake  Erie,  with 
an  approximate  passenger  traffic  income  of  10  per  cent.  The 
approximate  average  income  for  railroads  in  the  United  States 
is  30  per  cent  from  passenger  and  70  per  cent  from  freight 
traffic.  A  knowledge  of  the  diverse  character  and  distribution 
of  railroad  traffic  is  necessary.  First,  it  enables  one  to  judge 
the  importance  of  any  changes  taking  place  in  the  traffic  over 
a  period  of  years.  Secondly,  it  gives  a  check  on  the  relation- 
ship of  railroad  rates  to  the  total  income  and  the  character  of 
traffic,  and  their  respective  influences  on  the  amount  of  income. 
Thirdly,  the  stability  or  the  change  of  the  freight  traffic  over 
a  period  of  years  can  be  ascertained.  If  the  diversity  of  freight 
traffic  is  increasing,  and  both  an  absolute  and  proportionate  in- 
crease of  passenger  traffic  to  freight  traffic  is  taking  place,  the 
railroad  will  normally  show  stability  of  earnings.  On  the  other 
hand,  some  of  our  most  profitable  railroads  are  the  one  class 
traffic  railroads ;  such  as  the  iron  ore  carriers  of  the  Lake  Supe- 
rior ports.1  The  second  most  profitable  lines  are  the  anthracite 
coal  carriers,  which  carry  a  large  amount  of  freight  but  are 


'Examples :   Duluth,  Missabe  &  Northern  and  Duluth  &  Iron  Range. 


254  INVESTMENT  ANALYSIS 

constantly  endeavoring  to  increase  their  anthracite  freight.1 
There  are  also  other  roads,  approximately  75  per  cent  or  more 
of  whose  traffic  consists  in  the  carrying  of  bituminous  coal.* 
Even  some  of  the  big  trunk  lines*  have  at  least  50  per  cent  of 
their  traffic  in  coal.  All  of  these  cases  are  again  striking  ex- 
amples of  the  futility  of  attempting  to  analyze  a  single  factor 
outside  of  its  own  environs.  Large  coal  carrying  roads  are  an 
important  exception  to  the  general  assumption  of  diversity.  A 
preponderance  of  over  80  per  cent,  for  example,  of  grain  traffic 
would  not  have  the  same  results  and  would  eventually  prove 
costly.  A  study  then  of  diversity,  must  also  include  the  char- 
acter of  the  traffic,  as  well  as  all  the  general  conditions  under 
which  this  traffic  is  being  handled. 

The  analysis  of  traffic  has  been  greatly  facilitated  by  the 
uniform  classification  required  by  the  Interstate  Commerce 
Commission.4  The  general  classes  are  Products  of  Agriculture, 
Products  of  Animals,  Products  of  Forests,  Manufactures,  Mer- 
chandise, and  Miscellaneous.  Too  much  emphasis  must  not  be 
placed  upon  the  ratios  of  these  products  until  the  sub-classifica- 
tions have  been  checked,  for  a  preponderance  of  one  commodity 
in  the  classifications  would  make  a  decided  difference  in  the  com- 
parisons. For  example,  dressed  meats  and  all  of  the  by-products 
of  the  animal  are  included  under  the  general  classification  of 
Products  of  Animals.  If  a  railroad  has  a  very  much  larger  ratio 
of  dressed  meat-product-traffic  than  another  road,  it  would  have 
a  very  much  larger  total  income,  even  though  the  total  ratio  and 
the  absolute  tonnage  of  Animal  Products  were  the  same  for  both 
railroads.  Under  the  items  of  the  respective  classifications  there 
is  also  considerable  variation  as  to  the  commodities  which  lend 
themselves  to  carload  shipments  and  those  which  lend  them- 
selves to  shipments  in  partial  car  load  lots. 

Traffic  Density. — Efficiency  in  operation  of  any  corporation 


1Examples :  Delaware,  Lackawanna  &  Western,  Lehigh  Valley  and 
Central  Railroad  of  New  Jersey. 

2Examples:  Norfolk  and  Western,  Hocking  Valley,  Virginia  Rail- 
road. 

'Pennsylvania  and  Baltimore  &  Ohio. 

4Since  1907  when  all  railroads  accounts  were  standardized,  opera- 
tion of  railroads  can  he  compared  to  hetter  advantage  in  every  respect ; 
but  even  then,  as  no  two  cases  are  alike,  a  comparison  not  recognizing 
the  underlying  and  dominant  conditions  is  worthless. 


RAILROAD  BONDS  255 

means  the  intensity  with  which  the  plant  is  utilized.  The  total 
result  attained  by  a  corporation  has  little  significance  unless 
considered  in  relation  to  the  size  of  the  plant  and  the  extent 
to  which  the  plant  is  intensively  operated.  These  are  among  the 
very  first  things  asked  about  by  the  average  man  considering  an 
industrial  security.  Yet  the  same  man  will  pass  them  over  as 
irrelevant  factors  in  determining  the  weakness  or  strength  of  a 
railroad  system.  The  facts  of  operating  utilization,  however, 
give  him  the  concrete  evidence  of  the  significance  of  the  gross 
and  net  income  and  maintenance  accounts  of  the  railroad.  This 
utilization  of  the  plant  in  railroads  is  called  the  density  of 
traffie. 

The  density  of  the  freight  traffic  of  a  railroad  is  obtained  by 
dividing  the  number  of  tons  carried  one  mile  by  the  miles  of 
railroad  operated.  In  procuring  the  passenger  density,  the  same 
method  is  used,  except  that  the  total  number  of  passengers  car- 
ried one  mile  is  substituted  for  tons  carried  one  mile.  The 
measurement  is  here  again  reduced  to  a  unit  in  order  to  give  a 
basis  for  comparison  with  other  roads. 

All  analyses  of  the  density  of  traffic  must  be  compared  with 
the  mileage  operated  and  with  the  character  of  traffic  carried. 
If  the  mileage  of  a  railroad  should  be  increased  and  the  traffic 
density  decreased,  it  would  have  decreased  in  efficiency  of  ope- 
ration. If  it  increased  its  density  at  the  same  rate  as  its  mileage, 
it  would  only  be  holding  its  own.  But  an  increase  of  density  at 
a  faster  rate  than  the  increase  in  mileage  would  probably  indi- 
cate that  the  additional  amount  and  character  of  traffic  brought 
into  existence  by  the  increased  mileage  made  greater  density 
possible.  By  this  it  must  not  be  inferred  that  efficiency  rests 
only  on  density.  It  also  depends  on  car  loading,  utilization  of 
car  time,  increased  mileage  per  car  per  day,  improved  methods 
of  handling  cars,  motive  power,  etc. 

The  general  tendency  for  railroads  showing  an  increase  in 
gross  revenue  is  to  show  an  increase  in  density  of  traffic,  though  • 
a  shift  to  a  different  class  of  traffic  may  result  in  a  higher 
income  without  a  corresponding  change  in  the  density  of  traffic. 
Shifting  the  rates  on  the  same  class  of  traffic  would  also  have 
the  same  effect  upon  the  gross  income.  The  railroad  which  does 


256  INVESTMENT  ANALYSIS 

increase  in  both  mileage  and  density  is,  of  course,  in  a  stronger 
position  than  the  one  which  increases  in  mileage  and  not  in 
density.  A  growth  in  mileage,  however,  may  take  place  without 
an  increase  in  density,  where  the  maximum  density  of  traffic 
to  the  mileage  has  been  approached  in  a  particular  locality. 
This  would  mean  that  the  operating  manager's  efforts  would 
have  decided  limitations. 

To  insure  the  same  income,  a  railroad  with  a  heavy  class  of 
tonnage  must  necessarily  have  a  greater  density  of  traffic  than 
the  railroad  with  a  higher  class  of  traffic,  as  the  rates  of  the 
former  are  lower.  Consequently,  a  mere  listing  of  freight 
density  without  the  qualifications  emphasized  in  this  chapter 
under  the  topic  of  the  "Trainload  and  Carload,"  may  be 
misleading. 

If  the  difference  in  the  character  of  the  traffic  is  not  too 
marked,  a  comparison  of  results  with  other  railroads  is  for  all 
practical  purposes  a  sufficiently  accurate  basis,  from  which  to 
draw  conclusions.  With  equal  mileage  and  a  greater  density  in 
traffic  of  railroad  "A"  over  railroad  "B,"  the  former  must 
operate  more  frequent  trains  (See  Train  Frequency  and  Speed) 
with  greater  tonnage  and  a  smaller  ratio  of  "empties."  This  is 
the  same  principle  as  that  used  in  determining  the  effectiveness 
of  the  operation  of  an  industrial  plant.  It  means  merely  the 
most  effective  utilization  of  the  plant. 

Trainload  and  Carload. — The  trainload  and  carload  are  also 
valuable  indices  of  the  efficiency  of  the  operating  department. 
The  trainload  is  the  average  number  of  tons  of  freight  (revenue 
freight;  company's  business  must  be  eliminated)  carried  per 
train  per  mile  for  the  year.  As  translated  into  earnings  in  the 
following  chapter  (XV),  the  result  of  this  is  shown  in  the 
amount  earned  per  mile  run  by  each  freight  train  or  passenger 
train.  This  is  the  crux  of  the  whole  proposition  from  an  earn- 
ing point  of  view.  In  carload  statistics  the  carload  unit  is  a 
smaller  division  than  the  trainload,  giving  a  smaller  unit  for 
comparison.  If  the  trainload  is  not  given  in  the  railroad 
report,  it  is  easily  obtained  by  dividing  the  number  of  tons  of 
freight  carried  one  mile  by  the  train  mileage.  While  the  in- 
crease of  both  trainload  and  carload  indicates  a  growth  in 


RAILROAD  BONDS  257 

traffic  or  better  utilization  of  the  railroad — generally  both— 
neither  trainload  nor  carload  can  be  analyzed  apart  from  the 
topography  of  the  country  traversed  by  the  railroad,  or  the 
character  of  traffic.  Efficiency  in  operation  of  a  particular  sys- 
tem must  be  judged  not  on  the  basis  of  any  general  unit  of  train 
or  carload,  but  in  relation  to  its  own  locality  and  character  of 
traffic.  It  would  be  meaningless,  for  example,  to  make  a  com- 
parison of  the  Chesapeake  and  Ohio,  chiefly  a  coal-carrying- 
road,  with  the  Chicago,  Burlington  and  Quincy,  principally  a 
grain-carrying  road. 

Where  more  than  one  engine  is  used  on  a  heavy  train,  a  good 
check  upon  the  trainload,  and  an  even  more  accurate,  but  tech- 
nical analysis,  would  be  the  consideration  of  the  additional 
factor  of  engine  mileage.  For  a  road  that  is  constantly  com- 
pelled to  use  more  than  one  locomotive  on  heavy  trains,  as  with 
the  Denver  and  Rio  Grande,  the  importance  of  the  trainload 
unit  is  destroyed,  the  relation  of  the  trainload  to  the  operating 
cost  being  decidedly  changed.  Railroads  with  the  same  char- 
acter of  traffic  and  length  of  mileage  may  differ  in  trainloads, 
because  of  a  difference  in  topography  of  the  country  traversed 
by  their  tracks,  which  skill  in  management  cannot  always  over- 
come. Where  this  handicap  exists,  allowances  must  be  made 
for  it,  as  inefficiency  of  management  cannot  be  held  accountable. 

In  order  to  secure  this  maximum  efficiency  in  the  hauling  of 
freight  and  passenger  cars,  the  manager  must  attempt  both  to 
load  the  cars  to  their  capacity  and  so  route  them  that  the  length 
of  haul  for  empties  to  the  available  points  of  traffic  will  be 
reduced  to  a  minimum.  While  the  traffic  manager  may  succeed 
in  loading  his  cars  effectively,  the  statistical  results  obtained  by 
measurement  of  the  carload  will  have  the  same  short-comings 
as  a  measurement  of  the  trainload.  A  wide  variation  in  the  types 
of  cars  and  in  their  capacity  for  traffic  would  impair  the  result. 
The  same  is  true  of  a  difference  in  the  kinds  of  traffic ;  for  exam- 
ple, a  carload  of  high  grade  cloth  would  be  more  valuable  than 
a  carload  of  pig  iron.  But  again,  with  a  long  mileage  and 
diversity  of  traffic,  these  difficulties  offset  each  other,  and  the 
general  average  will  be  a  fairly  good  index. 

One  of  the  serious  problems  in  the  earlier  development  of 


258  INVESTMENT  ANALYSIS 

the  Western  trunk  lines  was  securing  a  sufficient  back  haul  to 
reduce  the  large  number  of  empties.  Traffic  was  taken  on  the 
narrowest  margins,  though  it  did  not  yield  the  system  a  legiti- 
mate profit,  for  the  cost  of  engineers,  trainmen,  coal,  and  wear 
and  tear  of  properties  continued  in  almost  the  same  proportion 
with  the  hauling  of  empties,  as  with  the  carrying  of  traffic. 
Where  a  large  interchange  of  traffic  can  be  secured  by  a  trunk 
•line  through  transfer  points,  like  Chicago,  the  problem  of  the 
operating  department  is  considerably  simplified,  as  both  a  large 
amount  of  long  haul  traffic  and  an  effective  loading  of  trains 
are  secured.  Where  there  are  decided  limitations  as  to  the 
amount  of  traffic  that  can  be  secured,  though  effectively 
handled,  a  railroad  can  never  expect  to  make  more  than  a  lim- 
ited showing.  The  quantity  of  traffic,  the  character  of  the 
traffic,  the  distance  of  the  haul,  and  the  topography  of  mileage 
will  always  create  decided  limitations  beyond  which  the  operat- 
ing department,  be  it  ever  so  efficient,  cannot  go.  This  is  a  fact 
too  often  not  taken  into  account  in  a  consideration  of  railroad 
rates. 

Where  the  tonnage  has  not  increased  with  the  growing  de- 
mand for  more  frequent  service,  the  increased  frequency  of 
service  on  a  smaller  system  will  check  the  development  of  the 
trainload  and  carload.  The  shipper  is  constantly  calling  for  a 
"hurry  up"  in  shipments,  which  may  be  entirely  opposed  to 
the  policy  of  the  operating  department  necessary  to  securing 
the  greatest  efficiency.  It  does  not  necessarily  follow,  however, 
that  heavy  trains  and  slow  speed  always  mean  efficiency,  for 
partial  loads  with  more  frequent  service,  have,  with  the  elimina- 
tion of  long  delays,  often  proved  the  more  profitable.  The  type 
of  topography,  traffic,  and  climatic  conditions,  must  determine 
and  will  limit  the  schedules  of  service  the  railroad  manager 
can  establish  to  secure  the  largest  returns  in  income. 

Terminals. — Efficiency  of  train  operations  outside  of  city 
limits  has  too  frequently  been  discounted  by  the  lack  of  term- 
inals or  inadequate  and  costly  methods  of  handling  freight  with- 
in the  city  limits.  A  railroad  must  have  good  terminal  facilities 
in  the  heart  of  the  city;  otherwise  it  will  fail  in  its  competition 
in  securing  traffic.  The  importance  of  this  factor  is  reflected  in 
the  large  investments  made  in  terminals. 


RAILROAD  BONDS  259 

A  few  systems  are  now  paying  large  prices  for  terminal 
facilities;1  an  outlay  which  might  have  been  at  least  somewhat 
reduced,  had  their  managements  anticipated  the  future  devel- 
opment of  the  systems.  If  a  subsidiary  terminal  is  owned  by 
a  railroad  or  a  group  of  railroads,  the  payment  of  leases  is  of 
relatively  small  concern,  but  if  the  rentals  are  paid  to  a  small 
group  of  individuals,  who  own  the  subsidiary,  these  leases 
may,  though  legitimate,  be  a  very  high  tax  upon  income.  In 
order  to  obtain  a  correct  estimate,  the  long  period  in  which 
this  property  has  been  held  until  its  present  value  has  been 
reached,  with  the  cost  of  the  investment  for  the  period,  must  be 
pitted  against  the  cost  of  the  rentals  at  present.  The  more 
costly  result  to  the  railroads  has  been  the  exorbitant  prices 
they  have  often  had  to  pay  for  additional  terminal  properties 
to  meet  the  necessities  of  expansion.  Inadequate  facilities  are 
likely  to  be  even  more  costly  than  high-priced  terminal  facili- 
ties. If  a  railroad  has  terminal  facilities  equivalent  to  only 
seventy-five  per  cent  of  its  traffic,  it  must  constantly  be  under 
strain  because  its  rolling  equipment  will  be  tied  up  by  the 
delays  caused  in  unloading.  There  is  no  means  of  measuring 
statistically  the  value  of  either  the  terminal  or  terminal  prop- 
erties, but  the  gain,  as  a  whole,  is  overwhelmingly  conclusive. 
And  it  is  in  this  total  influence  rather  than  any  attempt  at 
unit  analysis,  that  both  the  terminal  and  terminal  properties 
must  be  considered. 

It  is  quite  likely  that  in  the  relatively  near  future  Congress 
and  the  Inter-State  Commerce  Commission  will  require  the 
terminals  to  be  used  jointly.  When  this  occurs,  the  situation 
stated  above  will  have  no  bearing,  and  the  terminal  question 
will  be  wholly  analyzed  from  the  standpoint  of  traffic  which  can 
be  secured  or  interchanged  in  the  particular  terminal  city  or 
cities. 

Regulation  and  Control. — Since  1887  government  regulation 


irThe  Chicago  Great  Western  and  the  Pere  Marquette  (/.  C.  C.)  vol. 
xliv,  which  have  paid  a  heavy  charge  for  some  of  their  lights  of  way 
and  terminal  facilities,  are  good  illustrations  of  this.  The  vast  sums 
spent  by  the  Wabash  in  securing  a  terminal  in  Pittsburgh,  despite  the  ill- 
advised  move  in  this  case,  shows  the  importance  attached  to  the  ter- 
minals. 


260  INVESTMENT  ANALYSIS 

has  steadily  increased.  So  important  has  government  control 
become  over  all  classes  of  public  utilities  that  the  investor  can 
no  longer  disregard  the  influence  of  this  control  on  his  invest- 
ment. But  while  large  advantages  to  the  investor  have  grown 
out  of  some  of  this  control,  other  features  have  proved  a  handi- 
cap. Then,  too,  the  slowness  with  which  government  action 
responds  to  a  needed  change,  even  where  the  power  to  inau- 
gurate it  is  already  possessed  under  existing  statutes,  is  in  need 
of  correction.  The  difficulty  of  dealing  with  the  problem  of 
utility  control  is  reflected  in  the  many  legislative  changes  which 
are  constantly  taking  place.  These  changes  frequently  nullify 
a  previously  made  analysis.  A  brief  record,  however,  of  the 
development  of  railroad  regulation  seems  worth  while  in  so 
far  as  it  may  throw  light  on  its  future  trend  and  influence 
on  security  values. 

Under  the  Act  of  18871  which  created  the  Interstate  Com- 
merce Commission,  the  power  of  this  body  was  largely  confined 
to  the  hearing  of  cases  on  discrimination.  This  power  was 
gradually  extended  through  amendments,2  and  in  1906,3  the  power 
was  extended  from  the  mere  setting  aside  of  unjust  rates  to  the 
power  of  fixing  new  rates.  The  amendment  of  19104  gave  the 
Commission  the  further  power  of  acting  upon  its  own  initiative 
in  suspending  any  change  in  rates  pending  a  hearing.  The 
power  vested  in  the  Commission  to  suspend  rates  has  met  with 
rather  bitter  criticism  on  the  part  of  the  railroads.  Two  more 
recent  amendments  have  effected  even  more  drastic  changes. 
These  acts  are  commonly  known  as  the  Valuation  Act  of  1913 
and  the  Transportation  Act  of  1920.5  Without  question  further 
amendments  will  follow  very  soon,  changing  certain  features  of 
these  last  two  amendments  as  well  as  adding  to  them. 


*U.  S.  Act  Approved  February  4,  1887.     (24  Stat.  L.  379.) 

2Amendnients  to  Act  of  1887  to  date  were  as  follows :  March  2, 
1889  (25  Stat.  L.  855)  ;  February  10,  1891  (26  Stat.  L.  743)  ;  February  8, 
1895  (28  Stat.  L.  643)  ;  June  29,  1906  (34  Stat.  L.  584)  ;  June  30,  1906 
(34  Stat.  L.  838)  ;  April  13,  1908  (35  Stat.  L.  60)  ;  February  25,  1909 
(35  Stat.  L.  648)  ;  June  18,  1910  (36  Stat.  L.  539)  ;  August  24,  1912  (37 
Stat.  L.  566)  ;  March  1.  1913  (37  Stat.  L.  701)  ;  and  Feb.  1920. 

"Act  of  June  30,  1906  (34  Stat.  L.  838). 

4Act  of  June  18,  1910  (36  Stat.  L.  539). 

"Transportation  Act  of  Feb.  28,  1920  (commonly  known  as  the 
Cummings  and  Esch  Bill). 


EAILROAD  BONDS  261 

In  addition  to  the  regulation  by  the  Federal  government, 
forty-eight  states  have  passed  regulations  in  varying  forms. 
Much  of  this  state  legislation  is  open  to  severe  criticism.  Many 
of  these  laws  have  been  passed  under  the  stimulus  of  a  fad  pass- 
ing over  the  country.  As  a  consequence,  state  legislatures  have 
often  failed  to  study  fully  the  economic  effects  of  much  of  this 
legislation.  As  a  result,  a  good  deal  of  confusion  exists  between 
the  control  exercised  over  a  trunk-line  mileage  within  the  state 
and  the  control  over  its  mileage  as  a  transcontinental  system. 
This  confusion  in  security  issues  has  already  been  emphasized 
in  the  chapter  on  the  Regulation  of  Security  Issues.1  The  solu- 
tion of  these  difficulties  would  seem  to  rest  in  the  complete  con- 
trol by  the  Federal  government  of  all  railroad  regulation. 

The  recognition  of  the  right  of  Federal  jurisdiction  over  that 
of  the  state  has  already  been  strongly  advanced  by  the  develop- 
ment in  the  United  States  Court  decisions.  This  development  is 
clearly  defined  in  a  comparison  of  the  so-called  Granger  Cases* 
and  the  Shreveport  Rate  Case.3  In  the  earlier  cases,  the  courts 
were  both  in  doubt  as  to  their  jurisdiction  and  in  the  interim 
have  been  attempting  to  find  their  own  ground.  But  in  the 
Minnesota  Rate  Case,4  the  emphasis  would  seem  to  have  been  laid 
on  the  state's  exercise  of  power  over  Federal  rates,  while  in  the 
Shreveport  Case,  where  interstate  rates  had  already  been  estab- 
lished, the  Federal  control  was  recognized  over  that  of  the 
state. 

As  the  investor  is,  of  course,  primarily  concerned  with  the 
amount  and  stability  of  his  return,  this  is  the  particular  phase  of 
the  problem  in  which  he  is  interested.  And  as  income  is  depend- 
ent upon  the  rates  which  can  be  charged,  the  two  other  questions 
of  direct  bearing,  outside  of  any  specific  limit  which  may  be 
placed  upon  the  rate  charged,  are:  What  rates  can  be  charged 
for  service,  and  what  is  the  base  upon  which  rates  are  charged  ? 
That  is,  are  rates  to  be  placed  upon  the  physical  value  of  the 


Chapter  XII.     Regulation  of  Security  Issues. 

2A  leading  case  deserving  of  much  study  is  the  case  of  Munn  vs. 
Illinois  (94  U.  S.  113,  24  L.  Ed.  72). 

"Houston,  East  &  West  Texas  Railway,  et  al.  vs.  United  States,  et 
al.,  234  U.  S.  342  (1914). 

4Shepard  vs.  No.  Pac.  Ry.  Co.,  184  Fed.  765  (1911). 


262  INVESTMENT  ANALYSIS 

property,  the  total  capitalization,  the  actual  investment,  cost-of- 
service,  or  some  other  base? 

When  the  question  of  rates  first  came  before  the  courts,  as 
already  intimated,  they  were  uncertain  of  their  jurisdiction.  As 
Harleigh  H.  Hartman  states :  "The  courts  were  unwilling  to  con- 
sider rate-making  except  as  an  exercise  of  the  police  power. 
They  declined  to  classify  it  as  condemnation  of  the  service.  A 
sort  of  hybrid  theory  of  regulation  resulted,  which  holds  that 
the  State,  in  the  exercise  of  its  police  power,  may  limit  the 
return  to  prevent  the  utility  from  appropriating  the  interest  of 
the  public,  but  cannot  take  the  service  without  paying  the 
utility  what  it  is  really  worth.  When  such  a  point  in  rate- 
making  is  reached,  the  power  of  eminent  domain,  not  the  police 
power,  is  enforced,  and  the  due  process  of  the  Fourteenth 
Amendment  is  lacking  if  compensation  is  neglected.  The  equal 
protection  of  the  law  is  denied  the  utilities  because  other  busi- 
ness is  not  subject  to  such  confiscation.  The  right  of  the  judi- 
ciary to  intervene  and  enforce  the  constitutional  safeguards  of 
property  was  established."1 

With  this  advancement  of  its  control,  the  courts  were  forced 
to  adopt  a  base  upon  which  the  rate  would  be  placed  as  well  as 
a  definition  of  what  that  base  should  be.  "The  Court,"  as  the 
same  author  again  states,  "hesitated  to  adopt  valuation,  but 
finally  took  the  step.  Having  done  so,  it  realized  the  oppor- 
tunity for  injury  to  the  public  welfare  which  rate-making 
sought  to  protect  and  hastened  to  place  conditions  upon  valua- 
tion." In  the  earlier  cases  of  the  Supreme  Court,  this  step 
was  not  taken.3  In  the  development  of  its  principles  of  fair 
valuation,  the  Supreme  Court  also  failed  either  to  lay  down 
very  clear  distinctions  or  give  a  very  comprehensive  interpre- 
tation of  fair  value,  though  marked  progress  must  be  admitted. 

The  closer  knitting  of  the  two  problems  of  rate  and  valua- 
tion is  also  evident  in  a  study  of  court  decisions.  And  as  these 
decisions  must  control,  both  their  interpretation  and  trend 


1Harleigh  H.  Hartman,  Fair  Value,  1920,  p.  75.  See  also  Homer 
Bews  Vanderblue.  Railroad  Valuation  (1917),  p.  11. 

'Harleigh  H.  Hartman.  Fair  Value,  p.  75. 

8Homer  Bews  Vanderblue,  Railroad  Valuation  (1917),  Chapter  I, 
pp.  1-27. 


RAILROAD  BONDS  263 

should  be  known.  An  analysis  of  the  cases  themselves  can  best 
give  this.1  However,  whatever  the  method  of  valuation*  may 
be,  the  rate  of  return  must  be  commensurate  with  the  risk 
involved.  To  this  extent  every  public  utility  property  is  an 
individual  problem. 

However,  in  the  supposed  reduction  of  risks  to  the  minimum 
because  of  the  monopolistic  character  of  the  business,  the  con- 
clusion which  has  frequently  been  followed  is  that  a  fixed  rate 
should  be  established  and  everything  else  fixed  and  adjusted  to 
it.  Fortunately,  legislatures  and  commissions,  owing  to  the 
sudden  shift  in  prices  during  the  "War,  were  forced  to  recognize 
the  fallacy  of  this  long  and  commonly  accepted  principle  in 
franchises.  What  proved  to  be  almost  a  calamity  to  many 
public  utilities  may  prove  to  be  their  ultimate  salvation.  For 
without  question,  this  unfortunate  situation  forced  recognition 
of  the  absurdity  of  a  fixed  rate,  and  has  materially  hastened  a 
change  in  attitude  of  those  administering  government  regula- 
tion as  well  as  the  character  of  new  legislation.  This  is  clearly 
demonstrated  in  the  Federal  Transportation  Act  of  1920. 

Out  of  the  agitation  for  a  fair  adjustment  of  rates  in  and 
out  of  Congress  together  with  the  opinion  of  a  minority  that 
railroads  were  grossly  over-capitalized,  a  statute  was  passed 
providing  for  a  valuation  of  all  railroads  in  the  United  States.* 
In  another  two  years  from  this  writing,  or  probably  less,  the 
final  results  of  this  valuation  should  be  complete.  The  prelim- 
inary results  announced  by  the  Commission  on  July  1,  1920,  as 
of  December  31,  1918,  gave  the  investment  value  of  the  rail- 
roads of  the  United  States  at  $18,084,934,000  which  is  in  excess 
of  the  book  value  carried  by  the  railroads  by  $875,000,000. 
Contrary  to  the  belief  of  some,  that  railroad  valuation  would 
generally  show  large  over-valuation,  decidedly  the  opposite 
proves  to  be  the  case.  A  few  exceptions,  needless  to  say,  exist. 
A  very  close  relation  between  book  values  and  property  valua- 


1See  previous  suggestions  of  texts  on  Valuation  in  Chapter  xii  on 
Regulation  of  Security  Issues. 

2See  Chapter  xii. 

"Amendment  to  Interstate  Commerce  Act,  March  1,  1913  (37  Stat.  L. 
701). 


264  INVESTMENT  ANALYSIS 

tion  was  also  shown  in  the  early  valuations  of  Michigan, 
Minnesota,  South  Dakota,  and  Washington.  But  even  after  a 
valuation  has  been  accomplished,  if  rates  are  to  be  allowed  that 
will  insure  a  just  return,  the  rate  applied  to  a  particular  rail- 
road must  be  to  a  large  extent,  at  least,  an  individual  problem. 
The  impossibility  of  fixing  rates  in  this  fashion  without  dis- 
criminating against  cities  is  apparent.  And  no  doubt,  the 
framers  of  the  1920  Act  recognized  this  in  the  provisions  made 
for  consolidations. 

As  a  result  of  the  chaos  resulting  from  war  operation  and 
the  increased  costs  of  operation,  the  Transportation  Act  of  1920 
was  passed.  Of  a  certainty,  the  valuation  of  railways  by  the 
Interstate  Commerce  Commission  with  the  passage"  of  the  1920 
law,  now  assumes  a  much  more  definite  place.  This  can  be 
assumed  without  entering  into  a  discussion  of  the  merits  of  the 
various  methods  of  valuation.  Neither  would  it  be  advisable  to 
undertake  a  discussion  of  the  problem  of  valuation  in  the  brief 
space  which  could  be  allowed  it  in  this  book. 

While  the  passage  of  a  similar  statute  must  have  come 
sooner  or  later,  the  predicament  of  the  railroads  hastened  its 
passage.  And  while  the  Act  will  be  amended  in  some  important 
particulars,  "The  Act  of  1920  using  the  'fair  return  upon 
value'  formula  directs  the  establishment  of  schedules  with  the 
frank  aim  of  limiting  maximum  revenue.  In  short,  it  seeks  to 
secure  for  the  public  a  part  of  any  future  'unearned  incre- 
ments' which  may  accrue  in  railroad  earnings."  Where  it  is 
impossible  to  administer  the  act  with  perfect  justice  because  of 
such  peculiar  conditions  as  referred  to  earlier  in  this  chapter 
concerning  the  Denver  &  Rio  Grande — consolidation  seems  the 
only  answer.  And  what  can  be  expected  if  this  legislation 
remains  in  force,  will  be  the  regional  consolidation  of  railroads. 
Section  407  of  the  Act  would  seem  to  clearly  aim  at  this  result. 

The  Act  provides  that  for  the  two  years  following  March  1, 
1920,  a  return  of  5~y2  per  cent  shall  be  allowed  on  the  aggregate 
value  of  the  road.  The  Interstate  Commerce  Commission  is  to 
fix  this  value.  The  Commission  at  its  discretion  may  add  one- 


Bews   Vanderblue,   Railroad   Valuation   by   the  Interstate 
Commerce  Commission  (1920),  p.  2. 


RAILROAD  BONDS  265 

half  per  cent  to  provide  for  improvements,  betterments,  or 
equipment  chargeable  to  capital  account.  This  has  been  done. 
When  the  two  years  have  expired,  the  power  to  determine  what 
is  a  fair  rate  of  return  devolves  upon  the  Commission.  In  no 
instance,  as  was  claimed  by  some  in  the  early  months  of  the 
statute's  existence,  does  the  government  guarantee  a  5y2  per 
cent  return,  but  rates  shall  be  so  fixed  as  to  earn  5%  per 
cent  (now  6  per  cent)  on  the  aggregate  value  of  property  in 
an  area.  That  is,  the  Commission  can  divide  the  railroads  into 
five  or  six  divisions  as  seems  best  and  establish  common  rates 
for  the  railroads  within  the  group  or  for  all  railroads  as  the 
Commission  determines.1 

As  the  returns  can  never  be  the  same  on  every  railroad,  the 
Act  further  provides  that  when  a  road  earns  more  than  6  per 
cent  on  its  property  valuation,  one-half  the  surplus  above  this 
rate  is  paid  to  the  government  for  a  contingent  fund.  The 
other  half  is  retained  by  the  carrier  and  must  be  placed  in  a, 
reserve  fund  until  this  reserve  equals  5  per  cent  of  the  value 
of  the  property.  After  this  fund  has  reached  5  per  cent,  the 
fund  may  be  used  by  the  road  for  any  lawful  purpose.  If  the 
road  does  not  earn  the  6  per  cent  in  any  year,  this  fund  may  be 
drawn  upon  to  make  up  the  difference.  The  fund  paid  to  the 
Federal  government  will  be  known  as  the  revolving  fund  and 
will  be  used  as  a  fund  from  which  to  make  loans  (under  cer- 
tain regulations)  to  railroads.  With  this  control  of  a  maximum 
rate,  it  is  obvious  how  important  the  control  over  valuation 
becomes. 

On  the  other  hand,  while  many  have  seriously  objected  to 
the  method  of  control  in  fixing  a  maximum  rate  as  well  as  the 
valuation  upon  which  the  rate  is  to  be  fixed,  railroad  securities 
should  be  eventually  greatly  stabilized.  This,  of  course,  assumes 
proper  administration.  When  an  increase  in  wages,  materials, 

1  "The  several  systems  shall  be  so  arranged  that  the  cost  of  trans- 
portation as  between  competitive  systems  and  as  related  to  the  values 
of  the  properties  through  which  the  service  is  rendered,  shall  be  the 
same  as  far  as  practicable,  so  that  these  systems  can  employ  uniform 
rates  in  the  movement  of  competitive  traffic,  and,  under  efficient  man- 
agement, earn  substantially  the  same  rate  of  return  upon  the  value  of 
their  respective  railway  properties."  (Transportation  Act  of  1920,  Sec. 
407.  Amendment  to  Sec.  5  in  Interstate  Commerce  Act.) 


266  INVESTMENT  ANALYSIS 

etc.,  occurs,  the  Interstate  Commerce  Commission  now  has  au- 
thority to  make  a  corresponding  increase  in  rates  which  will 
yield  the  return  allowed  on  the  property  valuation  of  the  road. 
While  that  rate  after  two  years  must  be  determined  by  the  Com- 
mission, it  is  not  likely  that  the  rate  which  it  establishes  will 
be  confiscatory.  The  statute  would  then  be  doomed.  Though 
placing  the  control  of  all  three  factors — namely,  valuation,  rate, 
and  maximum  return — in  the  hands  of  this  single  Commission 
is  open  to  serious  question,  it  should  afford  considerable  elas- 
ticity in  operation  through  this  concentration  of  power  into  one 
body.  This  depends  on  whether  so  large  a  problem,  or  rather 
problems,  can  be  administered  in  this  fashion.  Added  to  this  is 
the  common  fault  of  the  slowness  with  which  government 
administration  operates.  Regardless  of  these  faults,  if  proper 
allowances  are  made  for  costs,  when  once  proper  consolidations 
are  perfected  and  the  administration  of  the  Act  is  properly 
functioned,  greater  stabilization  should  exist  in  railroad  security 
values. 


CHAPTER  XV 

REVENUES  AND  EXPENDITUEES 
EAILROAD  BONDS 

Income  and  Expenditure  Accounts.1 — Two  things  must  be 
kept  in  mind  in  the  analysis  of  a  railroad  statement:  first,  the 
relation  of  income  and  disbursements  to  the  physical  factors 
of  the  railroad;  second,  the  relation  between  the  income  state- 
ment and  the  balance  sheet.  The  latter  gives  the  strength  of 
the  investment  and  the  return  on  the  capital  invested,  while  the 
former  gives  the  results  of  operation.  To  enable  the  layman 
to  obtain  not  only  a  common  basis  for  comparison,  but  a  unit 
by  which  he  is  able  to  grasp  the  significance  of  the  income 
statement  and  the  balance  sheet,  all  operating  revenues  and 
expenditures  should  be  reduced  to  the  basis  of  the  mileage  unit. 
This  latter  is  now  made  possible  by  the  uniformity  of  railroad 
accounts. 

"While  the  measurement  of  gross  or  net  earnings  in  total 
sums  may  give  the  information  desired  for  a  particular  pur- 
pose, a  more  effective  cheek  to  a  many-sided  problem  is 
needed.  It  is  also  necessary  to  be  informed  as  to  the  importance 
of  any  related  corporation  or  subsidiary  and  the  relation  of 
earnings  to  capital.  This  is  possible  only  through  a  study  of 
the  detailed  items  of  the  income  statement  or  revenue  accounts 
to  the  balance  sheet.  Operating  revenues  may  reach  a  satisfac- 
tory amount  as  measured  in  terms  of  the  mileage  unit,  yet  the 

xThe  following  books  will  be  found  useful  to  the  student  in  the 
study  of  the  railroad  report:  Louis  Heft,  Holders  of  Railroad  Bonds 
(1916)  on  the  legal  problems;  F.  W.  Mundy,  the  Earning  Power  of 
Railroads  (Annual  since  1902)  ;  A.  M.  Sakolski,  American  Railroad 
Economics  (1913)  ;  Carl  Snyder,  American  Railways  as  Investments 
(1907)  ;  Suffern  &  Sons,  Railroad  Operating  Costs  (1911)  ;  Thomas  F. 
Woodlock,  The  Anatomy  of  a,  Railroad  Report  (1900).  Although  this 
publication  of  a  railroad  report  was  written  twenty  years  ago,  it  is  still 
a  standard  classic. 

267 


268  INVESTMENT -ANALYSIS 

return  on  the  capital  investments  will  not  be  an  adequate  one. 
A  comparison  of  these  latter  factors  is  merely  a  comparison  of 
the  operating  risk  and  efficiency  with  the  financial  risk. 

The  discussion  of  income  and  expenditures  in  this  chapter 
develops  the  principles  of  analysis,  as  related  to  both  operation 
and  capital.  The  summarized  statements  of  the  Interstate  Com- 
merce Commission  are  used  for  this  purpose.  The  income 
account  required  by  the  Interstate  Commerce  Commission 
brings  together  under  a  common  classification  all  the  sources 
of  revenue  and  the  larger  grouping  of  disbursements  which  are 
sufficiently  well  classified  to  secure  detailed  comparisons.  This 
exhibit,  according  to  the  last  official  classifications,  can  be  sum- 
marized as  follows: 

Operating  Eevenues: 
Revenue  from  Transportation 
Operating  Expenses 

Maintenance  of  Way  and  Structures 

Maintenance  of  Equipment 

Traffic  Expenses 

Miscellaneous  Operations 

Transportation  Expenses 

General  Expenses 

Transportation  for  Investment  (Cr.) 
Net  Operating  Revenue 
Income  from  Other  than  Operation 
Gross  Corporate  Income 
Deductions  from  Gross  Corporate  Income 

Taxes  (including  equipment) 

Rents  (including  equipment) 

Losses  from  Operating  Separate  Properties 

Interest  Charges 

Sinking  Fund  Requirements 

Net  Corporate  Income 

Distribution  of  Current  Net  Corporate  Income  to: 

Dividends 

Additions  and  Betterments 

Appropriation  to  Reserve 
Miscellaneous 
Balance  Carried  to  Profit  and  Loss 


RAILROAD  BONDS  269 

Operating  Revenues. — A  railroad's  operating  revenue  is  de- 
rived exclusively  from  the  operation  of  trains  over  its  mileage, 
income  obtained  outside  of  rail  operating  not  being  included. 
Operating  revenue  includes: 

(1)  Revenue  from  freight 

(2)  Revenue  from  passengers 

(3)  Revenue  from  express  and  mails 

(4)  Revenue  from  miscellaneous  transportation 

Freight  and  passenger  revenues  furnish  the  preponderance 
of  railroad  income  from  operation.  The  more  important  of 
these  two  sources  of  income  is  freight  revenue,  which,  in  the 
United  States,  yields  from  65  to  70  per  cent  of  the  railroad's 
operating  income.  The  amount  of  traffic,  in  either  case,  must 
be  studied  in  relation  to  the  railroad's  own  mileage  and  the 
problems  attendant  upon  its  geographical  location.  While  the 
general  freight  traffic  is  considered  the  most  profitable,  the  pre- 
ponderance of  gross  revenue  from  one  class  of  freight  on  one 
railroad  as  compared  with  another,  and  even  the  differences 
arising  among  roads  carrying  similar  traffic,  due  to  a  number 
of  local  influences,  often  make  direct  comparisons  of  the  gross 
revenues  of  two  or  more  railroads  very  misleading.  Allow- 
ances must  consequently  be  made  for  both  differences  in  traffic 
and  variations  in  operation.  For  illustration,  higher  carrying 
charges,  which  always  exist  with  higher  class  traffic,  tend  to 
reduce  the  advantage  of  the  higher  rate,  and  an  advantage  can 
only  accrue  in  the  carrying  of  this  traffic  where  the  proportion 
of  the  high  class  freight  greatly  increases,  so  that  the  law  of 
increasing  returns  will  operate  more  intensely.  The  problem  of 
productiveness  involved  in  this  analysis  brings  to  consideration 
the  relation  of  earnings  to  capitalization,  which  is  considered  in 
the  following  chapter. 

With  a  proper  appreciation  of  the  exceptions  and  limitations 
that  these  conditions  must  place  on  the  analysis  of  gross 
revenue,  the  simple  revenue  per  mile  unit  can  be  used  with 
safety.  It  is  only  upon  this  basis  of  unit  comparison  that  we 
can  also  benefit  by  a  comparison  of  the  analysis  of  the  physical 
factors.  The  general  tendency  and  status  of  gross  earnings,  it 
is  true,  can  be  determined  without  any  references  to  the  physi- 


270  INVESTMENT  ANALYSIS 

oal  factors  whatsoever,  but  it  would  be  impossible  to  ascertain  the 
basic  cause  of  the  present  condition  or  any  changes  without  them. 

Railroad  revenue  is  directly  dependent  upon  the  railroad 
rates.  If  costs  of  materials,  labor,  operations,  etc.,  did  not 
change,  once  the  rate  was  found  that  would  yield  an  equitable 
return,  railroad  operation  would  be  much  simplified.  But  costs 
do  not  remain  constant.  Even  before  the  War  the  cost  of  main- 
taining and  operating  railroads  was  rapidly  rising,  and  from 
1914  to  1920  the  pressure  of  upward  costs  was  even  more  severe. 
It  has  been  the  slowness  of  the  government  in  recognizing  this 
condition  and  its  relation  to  rates  that  has  caused  the  hard- 
ships to  railroads  which  still  continues  to  be  felt  by  many 
railroads. 

By  increased  efficiency,  railroads  for  several  years  offset  the 
disadvantage  of  increased  cost,  and  increased  efficiency  in  the 
future  may  change  this  limitation,  but  the  railroad,  no  more 
than  any  other  organization,  should  be  made  to  pay  the  discount 
in  the  present  for  the  advantages  that  may  arise,  either  from 
inventions  or  conditions  that  may  make  cheaper  operation  pos- 
sible, in  the  future.  Even  when  a  good  idea  is  conceived  by 
the  operating  manager,  the  very  size  of  our  railroad  organiza- 
tion generally  involves  months  of  delay  before  his  idea  can  be 
finally  incorporated  into  the  system  without  causing  enormous 
losses  arising  through  errors  in  readjustment.  Further,  the 
final  effect  of  readjustments  cannot  always  be  known  until  they 
are  applied  to  a  whole  system,  and  mere  experimenting  with  a 
ships  to  railroads  which  still  continue  to  be  felt  by  many 
serious  loss. 

High  operating  efficiency,  however,  may  not  overcome  the 
evil  effects  which  the  railroad  has  suffered  from  gross  over-capi- 
talization, especially  if  the  latter  is  made  the  basis  for  rates. 
To  force  a  charge  here  that  will  maintain  a  legitimate  rate  on 
the  capitalization  of  these  railroads,  will  not  be  considered 
equitable  from  the  standpoint  of  the  public  and  will  always  be 
contested,  regardless  of  any  justifications  for  it  that  may  be 
advanced.  The  only  salvation  of  these  railroads  is  financial 
reorganization,  and  with  a  very  few  exceptions,  this  has  already 
taken  place,  in  either  voluntary  or  receivership  reorganization. 


RAILROAD  BONDS  271 

The  process  of  eliminating  over-capitalization  by  building  up 
properties  to  the  point  of  a  justified  capitalization  out  of  earn- 
ings, is  rather  a  long  drawn-out  process,  and  so  not  always  a 
good  plan.  On  the  other  hand,  capitalization  has  been  a  greatly 
over-emphasized  influence,  though  the  numerous  possibilities  of 
its  utilization  makes  it  a  very  strong  cudgel  for  those  who 
oppose  rate  increases,  even  where  justified.  Fortunately,  a 
very  small  group  of  railroads  fall  into  this  category,  and  the 
preliminary  Federal  valuation  report  of  railroads  indicates 
that  the  present  capitalization  of  most  railroads  is  not  in  excess 
of  their  property  account.  While  capitalization  cannot  be  the 
only  factor  taken  into  account  in  a  consideration  of  railroad 
rates,  it  will  always  have  a  very  important  bearing  upon  them 
in  the  public  mind.  It  goes  without  saying,  that  if  an  auto- 
matic adjustment  of  railroad  rates  to  changing  costs  can  be 
made,  the  element  of  risk  in  rates  will  be  greatly  minimized. 
No  one,  however,  would  ever  maintain  that  the  subtle  forces  of 
supply  and  demand  can  be  moved  in  any  such  manner  as  the 
puppets  on  a  chess  board. 

Passenger  traffic,  though  furnishing  a  minor  part  of  the 
revenue,  can,  as  evidenced  in  past  experience,  prove  a  large  and 
uncertain  burden.  What  has  been  said  of  the  decrease  in 
freight  rates  and  the  establishment  of  an  equitable  rate  applies 
as  forcibly  to  passenger  rates.  The  amount  of  expense  due  to 
the  demand  for  passenger  equipment  has  gone  up  at  a  faster 
rate  than  passenger  returns,  though  this  has  been  partially 
offset  by  extra  fares.  Where  the  proportion  of  passenger  traffic 
is  relatively  large,  as  previously  stated,  the  examination  of  these 
items  becomes  increasingly  important.  For  the  large  Eastern 
trunk-line  systems  with  revenues  of  eight  or  more  figures,  a 
decline  of  a  few  per  cent  makes  large  inroads  into  net  profits. 

Revenues  from  other  sources  average  less  than  eight  per  cent 
for  the  railroads  of  the  United  States.  Though  some  of  this 
traffic  is  carried  on  close  margins,  the  rates  are  fairly  well  fixed 
and  the  fluctuations  are  consequently  slight  in  comparison  with 
the  total  revenue.  Where  losses  are  continued,  there  is  need  for 
close  scrutiny  of  the  subsidiary  items  of  this  account,  otherwise 
they  demand  little  attention. 


272 


INVESTMENT  ANALYSIS 


TYPICAL  INCOME  STATEMENT  OF  RAILROAD 
PRESCRIBED  BY  INTERSTATE  COMMERCE  COMMISSION 

Income  Statement  of  the  Pennsylvania  Co.  Lines  West  of  Pittsburgh 
For  the  Year  Ended  December  31,  19171 

Operating  Income :  1917 
Railway  Operating  Revenues : 

Freight    $56,199,622.05 

Passenger   13,792,898.89 

Mail    1,492,923.56 

Express    2.249,000.46 

All  other  transportation   2,010,043.15 

Incidental   2,899,820.44 

Joint  facility— Credit    45,407.18 

Joint  facility— Debit   94,418.30 

Total    "  '    $78,595,298.03 

Railway  Operating  Expense : 
Maintenance  of  Way  and  structures.  ..$  9,960,415.02 

Maintenance  of  equipment   14,751,751.94 

Traffic    1,099,815.72 

Transportation    34.474,709.67 

Miscellaneous  operation 581,076.66 

General    1,903,815.43 

Transportation  for  Investment— Credit         23,684.92 

Total    "  62.747,899.52 

Net  Revenue  from  Railway  Operations  $15,847,398.51 

Railway  Tax  Accruals $  4,524,571.80 

Uncollectible  Railway  Revenues 5,057.67 

4,529,629.47 

Railway  Operating  Income $11,317,769.04 

Railway  Non-Operating  Income : 

Joint  facility  rent  income $      256,089.24 

Income  from  lease  of  road 61,928.64 

Miscellaneous  rent  income 130,339.19 

Miscellaneous     non-operating    physical 

property    41,116.43 

Separately  operated  properties — profit.  8,162.56 

Dividend  income    10,456,382.42 

Income  from  funded  securities 414,258.19 

Income  from  unfunded   securities  and 

accounts    1,334,761.06 

Income  from  sinking  and  other  reserve 

funds   262.787.13 

Miscellaneous  income   92,898.41 

Total  non-operating  income "  13,058.723.27 

Gross  Income    $24,376,492.31 


'The  year  1917  was  taken  because  it  was  the  last  year  of  private 
operations.  At  the  present  writing  government  regulation  or  its  imme- 
diate influence  still  persists. 


RAILEOAD  BONDS 


273 


Deductions  from  Gross  Income :    $24,376,492.31 

Hire  of  equipment— debit  balance $  1,098,935.16 

Joint  facility  rents   688,913.72 

Rent  for  leased  roads 9,828,145.10  . 

Miscellaneous  rents   282,472.68 

Miscellaneous  tax  accruals  12,440.58 

Separately  operated  properties — loss . . .        123,330.76 

Interest  on  funded  debt 4,640,703.50 

Interest  on  unfunded  debt 463,641.84 

Maintenance  of  investment  organization       132,160.13 
Miscellaneous  income  charges 363,025.04 

Total  deductions  from  gross  income  17,633,768.51 

Net  Income    $  6,742,723.80 

Disposition  of  Net  Income: 

Income  applied  to  sinking  and  other  re- 
serve funds    $  1,356,955.89 

Dividend   appropriations   of   income    (six 

per  cent)    4,800,000.00 

Income   appropriated   for    investment   in 

physical   property    6,156,955.89 

Balance   transferred    to   credit   of   Profit 
and  Loss $      585,767.91 

PROFIT  AND  LOSS  STATEMENT 
Amount  to  credit  of  Profit  and  Loss,  Decem- 
ber 31,  1916 $  9,172,366.32 

Balance  of  net  income  for  the  year $     585,767.91 

Sundry  net  credits  Curing  the  year 640,556.08 

1,226,323.99 

Amount  transferred  being  unexpended  bal- 
ance of  surplus  appropriated  prior  to  1917 
for  investment  in  physical  property 6,071,870.93 

Amount  to  credit  of  Profit  and  Loss,  Decem- 
ber 31,  1917 $16,470,561.24 

Operating  Expenses. — Operating  expenses  of  a  railroad, 
though  subjected  to  more  careful  supervision  than  any  other 
items,  have  always  been  the  mark  for  the  severest  criticism.  A 
common  belief  is  that  to  correct  exorbitant  operating  expenses, 
the  railroad  management  needs  only  to  make  the  normal  re- 
trenchments practiced  by  any  industrial  corporation.  But  the 
wide  variation  in  the  character  of  railroad  traffic,  the  wide 
influence  to  which  the  traffic  is  subjected,  the  increasing  demand 
for  better  and  faster  service,  the  increasing  costs  of  labor  and 
material,  together  with  the  fixity  of  certain  items  of  expense, 
regardless  of  the  amount  of  traffic,  make  the  problem  of  oper- 
ating expenses  a  very  wide  and  much  more  complicated  one 


274  INVESTMENT  ANALYSIS 

than  the  average  industrial  corporation  is  compelled  to  face. 
There  are  no  doubt  systems  in  the  United  States  whose  operat- 
ing*expenses  in  the  past  have  not  been  curtailed  to  enrich  the 
coffers  of  a  few  unscrupulous  promoters.  Care,  however,  must 
be  constantly  exercised  in  the  examination  of  railroad  operating 
expenses,  not  to  confuse  the  difficulties  arising  out  of  increas- 
ing costs  of  labor  and  materials  with  inefficiency  of  the  operat- 
ing department. 

On  the  other  hand,  no  industry,  as  a  whole,  has  shown  the 
same  proportion  in  savings  from  operating  as  railroads.  A 
recent  editorial  states  in  this  regard : 

"Railroad  managers  have  corrupted  legislatures,  conspired 
with  monopolies,  grafted  in  various  forms  to  the  injury  of  their 
investors  and  the  public.  They  have  carried  on  foolish  and 
wasteful  or  selfish  financial  policies,  paying  dividends  where 
they  should  have  conserved  revenues,  wasting  in  supply  and 
operation,  issuing  new  securities  to  meet  expenses  which  should 
have  been  met  from  revenue.  They  have  been  tactless,  narrow, 
inconsiderate,  incompetent,  etc.,  etc.  That  is,  they  have  been 
human  beings  with  great  opportunities  and  great  temptations. 

"But  while  we  have  named  here  the  faults  of  railroad  man- 
agers  of  the  worst  type  and  some  of  the  faults  of  all,  we  ought 
to  recall  that  the  management  of  many  of  the  railroads  ranks 
among  the  most  admirable  achievements  of  American  practical 
genius.  Speaking  of  American  railways  in  general,  a  French 
expert  has  said :  '  The  railways  of  the  United  States  represent 
one  of  the  most  marvelous  efforts  of  human  industry  to  turn  to 
good  account  the  resources  of  the  country.  Through  the 
rapidity  of  development  and  the  decrease  in  transport  prices, 
the  railways  of  the  United  States  have  made  of  this  territory  a 
country  which  has  one  economic  life.  Notwithstanding  the 
criticisms  which  the  many  abuses  evoked,  they,  without  demand- 
ing of  the  state  anything  but  liberty  of  action,  have  been  the 
principal  factor  of  its  wonderful  growth  in  agricultural,  com- 
mercial, and  industrial  power,  which  may  shortly  attain  world- 
wide supremacy. '  "  * 

It  is  a  separation  of  the  sound  from  the  unsound  and  the 
ability  to  select  properties  carefully  and  efficiently  operated, 
that  the  discriminating  analysis  of  a  railroad  report  should  give 
the  investor.  This  recognition  of  general  conditions  affecting 

1Chicago  Daily  Tribune,  Editorial,  November  23,  1916. 


RAILROAD  BONDS  275 

the  industry  from  without,  and  the  existing  conditions  within, 
is  only  the  normal  method  of  procedure  in  any  analysis  before 
proceeding  to  the  separation  of  individual  properties  and  the 
analysis  of  the  specific  details  which  determine  weakness  or 
strength.  The  standardization  of  railroad  reports,  suggested  in 
the  beginning,  has  greatly  facilitated  these  analyses.  In  study- 
ing the  operations  of  a  property  over  a  series  of  years,  the  trend 
of  a  fundamental  influence  can  always  be  easily  detected, 
though  the  temporary  changes  are  not  always  so  evident.  An 
investor,  finding  any  indication  of  any  signs  of  uncertainty, 
should  demand  a  full  explanation;  or,  if  no  satisfying  answer 
can  be  given,  and  he  is  to  adhere  to  the  sound  principle  of  safety, 
he  should  eliminate  this  security  from  his  list. 

Operating  expenses  must  necessarily  fluctuate  with  the 
amount  of  traffic,  though  not  to  the  same  degree  as  with  changes 
in  the  gross  traffic  returns.  The  number  of  engineers,  con- 
ductors, etc.,  can  be  little  reduced,  even  if  traffic  falls  off  to  the 
extent  of  forcing  the  movement  of  half-filled  cars.  Also  fixed 
charges,  such  as  interest,  do  not  respond  to  the  temporary  fluc- 
tuation of  gross  revenue,  and  even  with  the  long  periods  of 
traffic  changes,  fixed  charges  respond  with  little  elasticity,  as  a 
large  part  of  a  railroad  must  always  be  in  the  form  of  fixed 
investment  regardless  of  the  amount  of  traffic.  As  a  result,  an 
increase  in  the  gross  revenue  will  render  a  larger  relative  in- 
crease in  net  profits  than  a  proportionate  reduction  in  operat- 
ing expenses.  The  operation  of  the  law  of  decreasing  costs  to 
the  increase  of  traffic,  however,  works  out  quite  differently  in 
its  effect  on  the  earnings  of  each  individual  railroad.  In  fact, 
even  if  a  railroad  were  run  at  a  continuous  loss,  it  would  be 
necessary  to  maintain  fixed  properties  almost  equal  to  those 
of  a  very  profitable  system.  Further,  a  railroad  property,  like 
any  industrial,  is  not  immune  from  market  depressions,  panics, 
or  crop  failures,  which  increase  or  retard  the  volume  of  its 
traffic.  Fixed  costs  is  the  most  common  basis  on  which  the 
finance  and  operating  departments  can  determine  what  the 
former  must  allow  from  the  surplus  of  the  plentiful  years,  so 
that  retrenchments  may  not  be  carried  beyond  the  point  of 


276  INVESTMENT  ANALYSIS 

injuring  either  the  permanent  efficiency  or  the  future  credit  of 
the  railroad. 

In  percentages,  the  approximate  division  of  the  three  prin- 
cipal individual  items  for  railroads  in  the  United  States 
included  under  the  previous  heading  of  Operating  Expenses 
are :  Maintenance  of  "Way  and  Structure,  approximately  20  per 
cent;  Maintenance  of  Equipment,  22  per  cent;  Transportation 
and  Other  Operating  Expense,  52  per  cent  of  the  total  Operat- 
ing Expense  Account.  Though  these  percentages  cannot  be  con- 
sidered the  basis  for  any  particular  system,  they  do  give  some 
approximation  for  the  proportion  that  should  exist  among  these 
items.  The  more  detailed  items  in  the  analysis  of  these  accounts 
can  be  procured  from  the  Interstate  Commerce  Commission  and 
are  essential  to  a  more  critical  analysis.  These  percentages 
will  fluctuate  slightly  from  the  figures  given  above,  but  they  can 
easily  be  checked  by  the  reports  of  the  Interstate  Commerce 
Commission. 

Of  all  the  items  under  operating  expenses  that  reflect  mana- 
gerial ability,  the  maintenance  accounts  are  most  illuminating. 
If  the  pressure  under  decreasing  earnings  becomes  very  great, 
the  easiest  recourse  for  relief  is  the  reduction  of  maintenance 
charges.  A  railroad  might  carry  its  maintenance  charges  for 
several  years  at  a  point  that  would  just  keep  the  system  going. 
But  this  policy  cannot  continue  indefinitely,  for  the  road  must 
eventually  rehabilitate  all  of  the  depreciated  property.  And, 
if  maintenance  accounts  have  not  been  adequately  met  for  sev- 
eral years,  the  cumulative  burden  upon  the  railroad  is  likely  to 
prove  so  difficult  that  heavy  fixed  obligations  will  be  necessary 
to  place  it  in  normal  working  order.  The  temptation  always 
exists  of  slighting  maintenance  in  order  to  continue  dividends, 
lest  the  credit  of  the  company  be  materially  affected.  It  is 
unfortunate  that  the  continuous  payment  of  a  dividend,  even  at 
the  sacrifice  of  legitimate  expenses,  has  been  countenanced  to 
the  extent  it  has  in  this  country.  This  practice  has  grown  out 
of  pressure  for  the  payment  of  dividends.  Controlling  inter- 
ests which  have  sought  to  gain  their  profits  from  speculations 
have  in  a  few  cases  sacrificed  the  interest  of  the  railroad  and 


RAILROAD  BONDS  277 

forced  the  payments  of  dividends  when  they  were  not  justified. 
The  savings  bank  laws  which  require  that  dividends  must  be 
paid  for  a  given  number  of  years  if  the  bonds  of  a  railroad 
are  to  be  made  legal  investments  for  savings  banks  may  have 
the  same  effect.  As  the  bonds  held  by  savings  banks  give  pres- 
tige to  credit,  the  road  may  sacrifice  in  order  to  maintain  these 
dividends.  The  continuation  of  the  dividend,  even  at  the  sacri- 
fice of  the  property,  has  sustained  the  market  price  which  has 
enabled  these  interests  to  obtain  their  profits.  But  again,  it 
has  been  only  the  weak  systems  that  have  resorted  to  this  ques- 
tionable procedure.  The  major  part  of  the  railroad  systems  in 
the  United  States,  to  the  contrary,  have  more  than  amply  pro- 
vided for  maintenance.  This  has  had  a  very  important  influ- 
ence, both  upon  the  long  continued  increasing  earning  power 
and  the  strength  of  credit. 

Maintenance  of  Way. — The  Interstate  Commerce  Commis- 
sion ruling,  which  has  now  been  in  full  effect  for  approximately 
twelve  years,  makes  a  careful  separation  between  capital  ex- 
penditures and  those  expenditures  which  are  strictly  for  main- 
tenance. It  is  perfectly  apparent  that,  unless  this  distinction  is 
followed,  a  maintenance  account  would  be  entirely  misleading. 
To  allow  all  maintenance  charges  to  be  capitalized,  would  cause 
increasing  capitalization  of  the  railroad,  and  would  correspond- 
ingly narrow  the  margin  back  of  the  security.  The  payments  to 
the  maintenance  account,  though  contrary  to  the  technical 
standpoint  of  accounting,  might  be  charged  to  capital  accounts. 
By  charging  to  capital  what  should  be  charged  to  maintenance, 
the  investment  will  appear  very  profitable  when  it  is  not.  The 
same  result  would  be  secured  as  to  profits,  during  the  early  life 
of  a  property,  if  no  allowances  for  the  future  were  made  during 
this  period.  The  payment  of  the  dividends  under  these  condi- 
tions would  more  and  more  necessitate  the  utilization  of  capital 
for  dividends,  and  no  one  needs  to  argue  here  the  weakening 
effect  that  this  must  have  on  the  finances  of  the  company. 

In  an  analysis  of  maintenance  charges  there  must  be  taken 
into  consideration:  (1)  the  number  of  tracks  and  mileage  of 
the  railroad,  (2)  the  geography  and  topography  of  the  territory 


278  INVESTMENT  ANALYSIS 

traversed,  (3)  the  character  and  density  of  traffic,  and  (4)  for 
comparative  purposes,  the  change  in  labor  and  material  cost. 

No  direct  ratios  can  be  established  between  these  items,  for 
even  though  two  of  these  items  may  be  fairly  constant,  the  pos- 
sible variation  of  the  other  items  would  destroy  the  value  of  any 
comparisons,  and  to  find  constancy  in  all  of  them  is  highly  im- 
probable. Neither  do  items  of  expense  increase  in  direct  pro- 
portion to  the  mileage.  A  double  or  three-track  system  will  not 
cost  two  or  three  times  as  much  as  a  single  track.  As  the 
necessity  for  increased  switches,  side-tracks,  and  other  terminal 
facilities  increases,  the  cost  will  again  increase,  though  not 
necessarily  in  a  direct  ratio,  for  an  increase  in  the  density  of 
traffic  may  result  in  greater  proportionate  increase  of  income. 
Doubling  the  density  of  traffic  will  also  increase  the  cost  of 
maintenance,  but  again  not  in  a  proportionate  ratio,  because 
of  the  operation  of  the  law  of  increasing  returns.  The  Pitts- 
burgh and  Lake  Erie,  on  account  of  its  four  tracks  and  its 
heavy  iron  ore  traffic,  had  a  maintenance  of  way  and  equipment 
charge  for  the  year  ending  December  31,  1917,  of  $34,172  per 
mile,  which  is  approximately  nine  times  that  of  the  Chicago  and 
Northwestern  Railway,  with  its  partly  double-tracked  line, 
though  the  latter  railroad  is  kept  at  a  high  standard  of  effici- 
ency.1 Under  any  consideration,  a  very  large  increase  in  main- 
tenance charges  can  only  be  justified  in  an  increased  trainload, 
increased  carload,  and  increased  density  of  traffic. 

Branch  lines  cannot,  on  the  other  hand,  from  the  standpoint 
of  economy  in  earnings,  be  maintained  beyond  a  certain  point. 
For  example,  ties  need  not  be  relaid  so  often  or  as  good  ties 
used  as  on  a  trunk  line.  This  would  apply  throughout  sub- 
sidiary line  maintenance,  particularly  where  the  traffic  was  not 
heavy.  This,  of  course,  does  not  imply  such  usages  as  those 
practiced  by  the  St.  Louis  and  San  Francisco  prior  to  its 
receivership  in  using  poor  ballast  for  the  grading  and  the  lay- 
ing of  rotten  ties. 

Topography  of  territory  traversed  has  a  very  direct  bearing 
upon  maintenance  charges.  The  maintenance  charges  of  a  rail- 


W.  Mundy,  Earning  Power  of  Railroads    (1918-19),  pp.  85 
and  92.     (These  figures  are  taken  from  Mr.  Mundy's  computations.) 


RAILROAD  BONDS  279 

road  in  a  mountainous  region,  a  right  of  way  subject  to  floods,1 
a  road  with  a  large  number  of  costly  bridges,  etc.,  will  neces- 
sarily be  greatly  enhanced,  as  compared  to  those  of  a  road 
carrying  traffic  of  a  similar  amount  and  character,  through 
level  territory.  These  variations  cannot  at  best  be  measured 
accurately,  though  the  examiner  should  always  be  able  to  place 
his  finger  on  specific  causes  in  order  that  he  may  be  able  to 
determine  the  reason  of  any  weakness  and  how  serious  that 
weakness  may  be. 

Every  comparative  study  of  operating  and  especially  of 
maintenance  accounts,  that  does  not  examine  into  the  change  in 
prices,  will  lead  to  wrong  conclusions.  Too  frequently,  the 
mere  increase  in  a  total  amount  put  into  maintenance  is  accepted 
as  indicating  a  stronger  position  of  maintenance.  So  large  have 
become  some  of  these  increases  that  they  demand  very  special 
attention.  On  the  basis  of  increased  cost  of  material,  labor, 
etc.,  some  of  the  weaker  systems,  especially,  will  not  show  as 
large  a  maintenance  charge  today  as  they  did  several  years  ago, 
though  the  actual  amount  shown  in  their  records  has  increased. 
The  operating  departments  of  the  weak  systems,  which  in  addi- 
tion to  these  increasing  costs  of  maintenance  have  also  had  to 
cope  with  the  over-capitalization  and  overbuilding  of  a  quarter 
of  a  century  ago,  have  had  an  almost  impossible  task.  Despite 
the  very  great  efficiency  in  operation,  it  has  been  an  impossible 
problem  with  some  of  these  systems.  But  the  efficiency  that  has 
been  evidenced  in  bringing  the  Atchison  Railroad,  for  example, 
out  of  the  chaotic  conditions  of  this  earlier  period,  when  almost 
all  of  its  bonds  were  considered  a  gamble,  to  the  position  where 
its  stocks  are  considered  a  strong  security,  will  always  stand  as 
a  lasting  tribute  to  the  genius  of  the  men  who  directed  its  man- 
agement. 

If  doubt  exists  as  to  proper  expenditures  for  maintenance, 
a  study  of  the  railroad's  statement  over  a  period  of  years  will 
soon  reveal  the  fact.  If  a  road  is  in  good  physical  condition 
and  the  expenditures  are  in  proper  alignment  with  the  expen- 
ditures of  other  years,  deduction  can  be  made  from  them  with 

*/.  C.  C.  Report,  31  p.  351  Sq.     An  interesting  case  will  be  found 
in  the  5  per  cent  cases  pertaining  to  the  Ohio  Floods  of  1913. 


280  INVESTMENT  ANALYSIS 

perfect  safety.  The  same  conditions  will  also  apply  where 
there  is  a  faulty  distribution,  for  example,  between  labor  and 
material  costs. 

Maintenance  of  Equipment. — The  first  essential  in  proceed- 
ing with  an  analysis  of  equipment  is  to  divide  the  data  into  the 
three  general  headings  of:  locomotives,  freight  and  passenger 
accounts,  and  to  subdivide  each  of  these  under  equipment  owned 
free  from  any  charge  and  equipment  under  lease.1  Any 
accepted  standard  of  measurement,  however,  should  be  checked 
and  counterchecked,  as  variations  in  the  actual  amount  of  equip- 
ment, size  and  character  of  equipment,  character  of  tonnage, 
and  the  character  of  the  railroad  mileage  may  destroy  the  value 
of  any  comparison  of  a  fixed  standard — a  fact  which  necessi- 
tates continual  verifications  and  counterchecks.  But  a  technical 
standard  of  measurement  or  measurements  is  absolutely  essen- 
tial for  any  approximate  interpretation  of  the  significance  of 
equipment  accounts.  To  say  merely  that  one  railroad  spends 
$10,000,000  and  another  $12,000,000  means  nothing,  for  the 
latter  might  have  greater  or  less  equipment,  or  Longer  or  shorter 
mileage,  or  a  heavier  or  lighter  tonnage,  any  one  of  which 
factors  or  combination  of  factors  would  change  the  original 
conclusion  based  upon  the  general  amounts. 

The  more  commonly  accepted  measurements  are  the  cost  per 
locomotive  mile  and  the  per  pound  tractive  power  for  locomo- 
tives, and  the  maintenance  per  car,  i.  e.,  the  maintenance  per 
car  mile  of  freight  and  passenger  cars.  Any  consideration  of 
maintenance  analysis  should  not  include  equipment  hired  under 
the  tests  given  above,  though  this,  as  far  as  general  results  to 
the  railroad  are  concerned,  might  be  more  than  offset  by  rent. 

If  the  variable  influences  which  will  tend  to  affect  the  con- 
clusions of  a  standard  measurement  are  fairly  well  ascertained, 
the  matter  of  essential  counterchecks  needed  to  ascertain  the 
limitations  or  the  necessary  conclusions  of  the  accepted  meas- 
urement will  be  considerably  simplified.  At  best,  a  correct 
measurement  is  rather  complex.  For  example,  the  cost  per 
locomotive  may  be  higher  in  railroad  "A"  than  in  railroad 


JSee  Chapter  xvii  on  Equipment  Securities. 


RAILROAD  BONDS  281 

"B,"  because  of  the  larger  type  of  locomotive  used;  and  the 
cost  per  pound  of  tractive  power  (i.  e.,  upon  the  amount  of 
traffic  hauled)  may  also  be  higher,  though  a  combination  of  the 
size  of  the  locomotive  and  the  traffic  hauled,  i.  e.,  per  locomo- 
tive mile  per  pound  of  tractive  power,  may  show  a  lower  cost 
for  railroad  ''A."1  The  same  results  might  also  arise  in  a  com- 
parison of  the  two  standards  of  measurements.  Before  meas- 
uring the  costs  of  equipment  maintenance,  the  difference  in 
steel  and  wood  equipment  should  be  noted,  for  the  repairs  of 
the  former  would  be  proportionately  less  than  the  latter.  A 
greater  number  of  cars  per  amount  of  traffic  hauled  will  also 
reduce  the  wear  and  tear,  and,  correspondingly,  the  cost  of 
maintenance.  The  distribution  of  the  company's  workshops 
and  the  policy  in  handling  repairs  will  always  make  some  varia- 
tions in  the  unit  costs.2  To  this  might  well  be  added  as  a  quali- 
fication, an  understanding  of  the  working  conditions.  For 
illustration,  it  might  cost  one  company  twice  as  much  as  an- 
other to  put  in  a  new  set  of  flues  and  the  job  might  not  be  as 
well  done. 

Transportation  and  Other  Expenses. — The  costs  for  the 
direct  moving  of  traffic  are  classed  under  the  following  heads 
in  the  income  statement:  traffic,  transportation,  and  general 
expenses.  Unlike  maintenance  charges  many  of  the  charges  for 
conducting  transportation  are  fairly  constant.  Consequently, 
any  saving  which  can  be  accomplished  in  the  lowering  of  these 
costs  is  a  very  positive  indication  of  increased  efficiency.  Any 
weakness  in  organization  will  likewise  very  early  reveal  itself 
in  transportation  costs.  But  caution  must  be  used  in  making 
any  comparisons  with  other  systems,  as  local  conditions,  char- 
acter of  traffic,  character  of  service,  etc.,  will  give  entirely  dif- 
ferent results. 

With  the  augmentation  of  a  railroad's  traffic,  the  costs  of 
conducting  transportation  must  increase,  but  at  a  decreasing 
ratio,  and  vice  versa.  And  the  more  rapidly  that  the  operating 
ratio  is  reduced,  the  more  efficient  is  the  operating  management. 
There  is  a  limit,  however,  in  the  decrease  of  gross  earnings  beyond 

JA.  M.  Sakolski,  American  Railroad-  Economics   (1913),  p.  203. 
•DM. 


282  INVESTMENT  ANALYSIS 

which  the  cost  of  conducting  transportation  does  not  follow. 
There  are  certain  charges  at  this  limit  which  cannot  be  lowered, 
or  are  lowered  with  the  greatest  of  difficulty,  regardless  of  how 
large  the  fall  in  gross  earnings  may  be. 

Maintenance  charges,  it  will  be  remembered,  if  they  have  been 
adequately  met  from  year  to  year,  are  a  reserve  for  the  future 
which  railroads  have  frequently  made  use  of  by  curtailing  main- 
tenance during  a  period  of  strain.  But  transportation  costs 
must  be  met  as  they  arise.  Once  spent  they  are  permanently 
gone  and  no  future  benefits  can  form  a  reserve  for  these  expendi- 
tures. On  the  other  hand  any  reduction  of  consequence  in  these 
costs  on  an  established  system  entails  an  increased  capital  outlay 
in  permanent  investment  to  make  such  a  reduction  possible. 
The  cutting  of  grades  and  curves  for  example  will  often  cause  a 
large  saving  in  fuel  costs.  A  railroad  management  must  con- 
stantly be  pitting  its  transportation  costs  and  their  possible 
reduction  against  the  cost  of  any  capital  expenditures  which  it 
may  make  to  affect  a  reduction  of  transportation  costs.  The 
security  of  transportation  costs  has  become  increasingly  impor- 
tant as  railroad  regulation  has  become  more  and  more  rigid,  and 
this  condition  will  tend  to  increase  rather  than  decrease. 

Individual  items,  such  as  fuel  costs,  labor  costs,  yard  costs, 
which  cannot  be  covered  in  detail  in  a  volume  of  this  character, 
give  a  great  deal  of  evidence  as  to  where  the  weakness  in  con- 
ducting transportation  may  exist.  When  the  conducting  of 
transportation  runs  over  40  per  cent  of  gross  revenue,  the  situ- 
ation of  the  average  railroad  approaches  rather  an  impossible 
situation.  If  locomotive  fuel  costs  go  over  15  per  cent  of  gross 
earnings,  real  danger  to  the  financial  position  of  the  road 
exists.  Fuel  costs  should  approximate  about  10  per  cent  or. 
less  of  the  railroad's  gross  earnings.  Of  the  items  making 
up  the  conducting  of  transportation  costs  locomotive  fuel  costs 
probably  should  average  between  25  to  35  per  cent.  With  the 
increasing  cost  of  fuel  this  item  needs  to  be  particularly 
watched,  and  if  any  reduction  in  this  outlay  can  be  accom- 
plished without  sacrifice  elsewhere,  it  should  be  looked  upon 
with  a  good  deal  of  favor.  Such  costs  as  clearing  wrecks, 
personal  injury  charges,  etc.,  which  the  average  individual 


RAILROAD  BONDS  283 

seldom  even  thinks  of  in  the  study  of  the  railroad  report, 
though  relatively  small  to  the  total  of  all  expenses,  will  average 
as  high  as  3  per  cent  of  gross  earnings.  Again  yard  costs  as  a 
whole  may  be  unduly  high.  The  neck  of  the  bottle  in  yard  oper- 
ation may  be  getting  the  locomotive  out  of  the  roundhouse. 
The  student  will  find  much,  for  example,  in  a  comparison  of  the 
expense  of  yards,  etc.,  of  such  roads  as  the  New  York,  New 
Haven  and  Hartford  and  the  Union  Pacific  system  that  will  give 
him  an  appreciation  of  railroad  finance. 

Labor  is  another  leading  item  in  transportation  costs.  In- 
crease in  wages  due  both  to  the  power  of  the  railroad  union 
organizations  and  legislation  has  often  forced  the  railroads  to 
comply  with  their  demands  regardless  of  the  business  conditions 
which  prevailed.  The  principal  offset  to  this  has  been  an 
increase  in  efficiency  of  operation — certain  increases  in  rates 
have  been  allowed  but  never  sufficient  to  offset  these  differences. 
A  peculiar  situation,  for  example,  arose  in  1920,  and,  though  an 
aggravated  case,  illustrates  the  kind  of  problem  which  the  rail- 
roads have  had  to  face  from  time  to  time.  A  rate  increase  was 
allowed,  but  in  July  a  wage  increase  was  also  allowed  and  made 
retroactive  from  the  first  of  May,  1920.  This,  together  with  the 
slowing  up  of  business,  cut  down  the  possible  revenues  counted 
on  with  the  increase  of  rates,  and  forced  an  unexpected  increase 
in  the  operating  costs  for  the  year.  While  much  might  be  added, 
because  of  the  great  importance  of  conducting  transportation, 
this  statement  of  the  problem  will  suggest  the  character  of 
analysis  essential  in  dealing  with  the  costs  of  conducting  trans- 
portation. Traffic  and  general  expenses  are  very  much  smaller 
with  a  narrow  fluctuation  in  amount,  and  therefore  do  not 
demand  the  close  scrutiny  necessary  in  observing  the  specific 
items  under  transportation.  Expenses  will  normally  vary 
directly  with  the  traffic  density — a  fact  which  is  due  to  the  rela- 
tion of  costs  to  train  mileage,  for  as  the  density  increases,  train 
mileage  increases.  Where  two  roads  are  hauling  the  same  type 
of  traffic,  but  the  one  has  a  much  larger  ratio  of  expense  to  gross 
revenue,  either  the  rates  received  are  lower,  or  the  efficiency  of 
management  is  inferior. 

Operating  Ratio. — The  percentage  of  the  operating  expense 


284  INVESTMENT  ANALYSIS 

to  gross  earnings  which  is  commonly  but  often  loosely  used  should 
be  employed  with  caution.     The  percentage  of  gross  operating 
ratio  is  more  frequently  used  than  any  other  index  of  the  meas- 
ure of  efficiency.    When  the  volume  of  business  is  constant,  and 
other  things  are  equal,  it  is  a  very  accurate  measure  of  mana- 
gerial efficiency ;  but  railroad  business,  as  with  other  businesses, 
is  dynamic,  not  static,  i.  e.,  it  is  not  constant,  neither  do  other 
things  remain  equal.    Unless  these  changes  are  recognized  and 
given  their  proper  consideration,  the  operating  ratio  is  mislead- 
ing.   The  operating  ratio  is  only  valuable  in  so  far  as  it  is  taken 
into  consideration  with  other  factors.    A  more  accurate  method 
of  determining  the  burden  of  operating  expenses  is  to  take  the 
five  chief  subdivisions  under  operating  expenses   (indicated  in 
the  previous  outline)  and  to  reduce  each  item  to  its  percentage 
of  gross  earnings.     Thus  several  ratios  are  virtually  obtained, 
which  make  not  only  a  broader  basis  of  comparison,  but  a  very 
much  more  accurate  method  of  detecting  weaknesses.    The  oper- 
ating ratio,  itself,  neither  shows  the  potential  power  of  capital 
invested,  nor  indicates  whether  there  is  inefficiency  in  manage- 
ment or  a  dearth  in  business.    As  one  author  states:  "No  indica- 
tion of  causes  is  afforded.    The  operating  ratio  may  point  to  the 
existence  of  disease;  but  it  is  no  further  help  in  diagnosis." 
And  even  the  separation  of  the  operating  expense  items  sug- 
gested above,  does  not  assist  in  locating  the  difficulty,  except  as 
it  is  taken  into  consideration  with  other  factors. 

Conditions  requiring  a  different  emphasis  upon  the  operat- 
ing ratio  of  the  various  railroads  are  considerable  in  number, 
and  can  be  determined  only  in  a  study  of  the  individual  rail- 
road. A  difference  in  the  financial  policy  of  some  railroads  in 
the  past  in  charging  to  operating  what  other  roads  have  charged 
to  permanent  improvements,  necessarily  has  resulted  in  large 
divergences  under  similar  operating  conditions.  This  differ- 
ence, however,  has  been  eliminated  since  1907,  as  only  certain 
definite  items  can  now  be  charged  to  the  capital  accounts. 

A  very  rapid  increase  of  the  mileage  of  the  main  line  of 
a  railroad,  or  an  increase  in  the  mileage  of  branch  lines,  gen- 

1William  Z.  Ripley,  Railroads,  Finance  and  Organization,  p.  164. 


RAILROAD  BONDS  285 

erally  increases  operating  ratios.  When  a  large  proportion  of 
the  tonnage  is  high-grade  traffic,  or  an  increase  in  trainloads 
and  density  of  low  grade  traffic  is  brought  about,  there  is  a 
tendency  to  decrease  the  operating  ratio.  Experience  has  shown 
that  the  opposite  condition  may  exist — namely,  a  high  operat- 
ing ratio  on  a  railroad  carrying  a  high  grade  of  traffic — and 
it  may  yield  larger  profits  on  its  investments  than  a  railroad 
with  sparse  traffic  and  a  low  operating  ratio.  A  well-built 
railroad  will  reduce  the  operating  expenses,  though  the  in- 
creased burden  of  the  fixed  charges  must  be  offset  against  the 
reduction  of  operating  to  prove  the  profitableness  of  the  for- 
mer. Differences  in  the  length  of  haul,  the  proportion  of 
freight  to  passenger  business,  the  amount  of  local  and  through 
traffic,  and  the  variation  from  year  to  year  of  the  total  volume 
of  traffic — all  have  an  important  influence  on  the  trend  of  the 
operating  ratio.1 

There  has  also  been  for  several  years  a  constant  increase  in 
the  operating  expenses,  due  to  the  increased  cost  of  materials 
and  labor,  and  but  for  the  increased  operating  efficiency,  these 
costs  would  have  increased  the  operating  ratio  to  a  greater 
degree  than  they  have.  Increased  costs  have,  no  doubt,  been  the 
major  influence  in  the  increase  of  the  operating  ratio,  but  it  is 
not  the  only  factor  that  may  bring  about  an  increase  of  the 
operating  ratio,  as  has  already  been  stated.  Practically  every 
type  of  corporation,  as  well  as  a  railroad,  now  must  make  every 
effort  to  secure  greater  utilization  of  its  fixed  property,  by  oper- 
ating on  narrow  margins,  and  thus  increase  the  volume  of 
business  so  that  the  total  net  profits  on  the  capital  investment 
will  be  larger.  To  the  extent  that  this  influence  affects  an 
increase  of  operating  ratio,  it  is  desirable  from  the  standpoint 
of  the  corporation  and  the  public. 

Net  Operating  Revenue. — The  net  operating  revenue  is  the 
balance  left,  after  the  deduction  of  operating  expenses  from  the 
operating  revenue.  As  every  writer  on  railroad  analysis  points 
out,  these  items  are  very  frequently  confused  and  it  should  be 


'See  also  Railroad  Act  of  Feb.  28,  1920,  Sections  209,  422  (Sec.  15a), 
for  temporary  and  permanent  changes  affecting  railroad  expenses. 


286  INVESTMENT  ANALYSIS 

kept  clearly  in  mind  as  to  what  they  represent.  Net  operating 
revenue  does  not  include  income  from  any  other  source  except 
the  actual  operation  of  the  plant.  It  is  the  representation  in 
financial  results  of  the  operating  management  of  the  railroad. 

It  is  self-evident  from  the  very  method  by  which  net  operat- 
ing revenue  is  obtained  that  any  analysis  of  it  should  be  made 
after  operating  expenses  have  first  been  analyzed.  If  any  of  the 
items  of  operating  expenses,  which  are  subject  to  considerable 
elasticity,  are  temporarily  sacrificed  or  curtailed,  because  of 
business  depression  or  other  adverse  conditions,  any  conclusions 
based  upon  operating  revenue  alone  would  not  be  correct.  And 
if  the  policy  of  sacrificing  operating  costs  has  been  maintained 
for  several  years,  in  order  to  make  a  good  showing  in  net  earn- 
ings, the  consequences  are  apparent.  It  is,  however,  not  an 
infrequent  mistake  even  for  bond  salesmen  to  refer  to  the  net 
operating  revenues  as  an  indication  of  strength,  with  no  refer- 
ence to  the  above  qualifications  that  may  exist.  When  net 
operating  revenue  increases  are  due  to  the  increase  of  gross 
business,  and  the  proper  provisions  for  operating  expenses  are 
made,  they  do,  needless  to  say,  indicate  increasing  strength. 

Another  very  common  mistake  is  the  comparison  of  railroads 
on  the  basis  of  the  net  operating  revenue  per  mile.  This  has  no 
significance  whatsoever,  unless  at  the  same  time  a  direct  com- 
parison is  made  with  the  capital  investment.  A  steady  growth 
in  net  operating  revenue,  itself,  might  take  place,  and  it  would 
normally  be  assumed  that  the  railroad  was  decidedly  strengthen- 
ing its  position;  but  when  this  same  increase  is  compared  with 
the  new  addition  made  to  property,  either  through  increased 
investment  from  the  outside,  or  surplus  earnings,  the  rate  of 
return  on  the  investment  may  prove  to  be  decreasing,  i.  e.,  the 
proportion  of  fixed  investment  to  the  rate  of  return  on  the  oper- 
ation of  properties  has  become  too  large. 

Taxes. — Taxes  were  formerly  included  as  a  part  of  operating 
expenses.  Taxes  are  now  separated  and  must  be  subtracted  from 
net  operating  revenue  before  any  other  claims  can  be  made  upon 
this  fund  by  any  other  accounts.  The  Interstate  Commerce 
rule  states,  "and  for  that  reason,  it  is  deducted  before  arriving 
at  the  figure  which  represents  the  amount  transferred  to  the 


RAILROAD  BONDS  287 

corporations,  etc."  Twenty  years  ago,  the  proportion  of  the 
expenditure  in  taxes  to  earnings  was  relatively  small.  This  is 
no  longer  true,  as  the  tax  payments  each  year  have  become  an 
increasing  burden.  The  burden  has  usually  been  the  greatest 
on  the  non-dividend-paying  roads,  as  a  few  statutes  have  made 
no  distinction  in  the  levying  of  taxes  upon  the  railroads  less  able 
to  pay.  The  lack  of  uniformity  of  state  taxation  of  corporations 
commented  upon  in  an  earlier  chapter,  is  particularly  applicable 
in  the  case  of  railroads.  It  is  only  when  the  antiquated  tax 
systems  of  many  of  our  states  have  been  relegated  to  the  junk 
heap  that  anything  like  equitable  uniformity  can  be  procured. 

Other  Income. — The  total  amount  of  Other  Income  of  rail- 
roads ranges  from  1  to  50  per  cent  of  the  total  net  income  which 
can  be  used  in  the  payment  of  interest  and  dividends.  For  all 
railroads  of  the  United  States  the  average  proportion  of  Other 
Income  to  the  Total  Net  Eevenue  accounts  of  railroads  approxi- 
mates about  30  per  cent.  The  major  part  of  this  income  is 
derived  from  the  ownership  of  stocks  and  bonds  of  other  com- 
panies, or  the  control  of  securities  as  holding  companies.  This 
proportion,  consequently,  assumes  large  importance,  especially 
to  the  stockholder,  for  any  considerable  fall  of  the  income  from 
this  source  will  determine  whether  any  dividends  shall  be  paid. 

Where  Other  Income  is  a  large  proportion,  the  analysis  of 
the  subsidiary  accounts  becomes  as  important  as  an  analysis  of 
the  operating  accounts  of  the  railroad.  In  such  cases,  it  is  neces- 
sary to  proceed  with  the  same  kind  of  an  examination  of  the 
operating  accounts  that  is  made  of  the  parent  company's  report. 
It  is  also  important  to  determine  whether  these  securities  are 
carried  in  the  balance  sheet  at  a  valuation  somewhat  near  their 
income  basis.  When  the  holdings  are  large  and  the  subsidiaries 
are  not  profitable,  the  carrying  of  the  securities  at  par  gives  an 
entirely  disproportionate  conception  of  the  valuation  of  the 
parent  company's  assets.  If  these  holdings  are  carried  much 
below  their  real  valuation,  it  may  be  an  indication  that  an  abnor- 
mally large  amount  is  thrown  back  into  the  properties  of  the 
subsidiary  companies.  If  the  subsidiary  is  itself  a  holding  com- 
pany, these  large  sums  may  be  placed  back  into  properties  of 
some  weak  company  of  its  own.  This  at  once  raises  the  question, 


288  INVESTMENT  ANALYSIS 

in  turn,  as  to  what  proportion  of  the  income  of  subsidiary  prop- 
erties is  derived  from  Other  Income.  A  large  proportion  from 
Other  Income  complicates  the  problem  much  more  and  makes 
any  analysis  correspondingly  more  difficult. 

Profits  to  an  unjustified  extent  may  be  taken  out  of  a  well- 
paying  subsidiary  by  the  parent  company,  to  make  up  for  either 
deficiencies  in  its  own  operating  account,  or  the  inflation  of  its 
own  profit  and  loss  accounts.  The  ultimate  outcome  may  be  the 
"skinning"  of  the  subsidiary.  On  the  other  hand,  if  the  parent 
company  continues  to  credit  revenues  to  its  accounts  that  are  due 
but  not  paid,  it  will  lead  to  a  large  accumulation  of  paper  profits. 
While  this  is  a  legitimate  practice,  according  to  accounting  prin- 
ciples, it  is  in  effect  a  padding  of  the  asset  accounts.  Lastly,  the 
permanency  and  the  fluctuations  of  Other  Income  must  be  closely 
studied.  If  the  latter  is  a  very  large  part  of  the  total  net  revenue 
of  the  railroad,  serious  consequences  may  follow  a  business 
depression  of  long  duration. 

Net  Corporate  Income. — The  fixed  deduction  charges  are 
what  are  known  as  fixed  charges;  namely,  Interest,  Rent,  and 
Sinking  Fund  Accounts.  The  value  of  the  analysis  of  these 
charges  can  be  greatly  enhanced  by  the  additional  analysis  of 
these  items  on  a  mileage  basis.  In  any  comparative  study,  the 
years  prior  to  1907  cannot  be  compared  to  those  subsequent  to 
1907,  as  taxes  were  often  included  in  fixed  charges.  The  same  is 
true  of  the  Equipment  Accounts,  which  formerly  were  placcJ 
somewhere  under  the  caption  of  operating  expenses. 

As  with  other  unit  mileage  analysis,  a  low  or  high  fixed  charge 
per  mile  of  itself  has  no  significance.  The  road  with  a  fixed 
charge  per  mile  three  times  as  large  as  that  of  another  system 
may  have  a  lighter  burden  than  the  latter,  even  though  the  per- 
centage of  gross  may  be  the  same  in  both  roads.  These  charges 
must  be  examined  in  the  light  of  density  of  traffic,  gross  earn- 
ings, and  operating  expenses,  before  any  ruling  can  be  passed 
upon  the  stability  or  strength  of  their  position.  For  example, 
one  of  the  most  common  methods  of  measuring  the  security  of  the 
interest  is  on  the  basis  of  the  size  of  the  ratio  of  net  profits  above 
the  fixed  charge  requirement.  Such  a  ratio,  without  taking  into 
account  the  actual  amount  of  the  fluctuation  in  operating  ex- 


RAILKOAD  BONDS  289 

penses,  or  the  stability  of  gross  earnings,  can  have  little  signifi- 
cance. As  a  normal  thing,  the  percentage  of  fixed  charges  will 
be  in  an  inverse  ratio  to  gross  income.1 

The  rental  charges  include  such  items  as  terminal  facilities, 
trackage  rights,  transfer  privileges,  etc.  As  the  demand  for 
these  facilities  as  well  as  the  number  of  subsidiaries  controlled  by 
one  system  has  increased,  the  importance  of  these  rental  charges 
has  also  increased.  The  contracts  under  which  these  privileges 
are  made  vary  widely,  though  the  charges  are  continuous  and 
must  be  paid  before  either  the  interest  or  sinking  fund  require- 
ments are  met.  An  examination  of  some  of  the  newer  leases  of 
the  South  and  Southwest  shows  either  losses  or  very  narrow 
margins  of  profit.  Probably  no  better  example  could  be  cited  in 
proof  of  this  statement  than  the  former  guarantee  of  high  divi- 
dends by  the  St.  Louis  and  San  Francisco  Kailway  on  the  Chi- 
cago and  Eastern  Illinois  properties.  This  guarantee  was  one 
of  the  main  reasons  for  the  receivership  of  the  former.  The 
Chicago  and  Eastern  Illinois  properties,  which  were  first 
"milked"  by  its  lessor,  later  proved  a  drain  which  could  not 
be  overcome.  But  at  the  same  time  the  St.  Louis  and  San 
Francisco  did  guarantee,  under  lease,  the  Kansas  City,  Fort 
Scott  and  Memphis  preferred  stock.  Under  the  reorganiza- 
tion there  was  never  for  a  moment  any  question  that  this 
latter  lease  would  be  broken,  for  the  property  was  far  too 
valuable  for  the  St.  Louis  and  San  Francisco  to  take  any 
chance  of  losing.  Yet  it  might  be  unprofitable  for  the  leases 
rendering  yearly  deficits  to  be  terminated,  as  they  might  have  an 
important  bearing  upon  the  total  net  income  of  the  road.  Con- 
siderable emphasis  should  be  made  in  these  deficit  leases,  as  to 
whether  these  losses  are  increasing  or  decreasing.  With  proper 
management,  they  may  ultimately  prove  valuable  holdings. 

The  interest  charges  fall  into  three  groups:  the  interest  on 
floating  debt,  interest  on  ' '  equipment  trusts, ' '  and  interest  upon 
funded  debt.  The  first  of  these  charges  is  relatively  very  small ; 
so  any  fluctuation  that  may  occur  has  little  perceptible  influence. 

'This  principle  of  ratio  is  well  illustrated  by  Floyd  W.  Mundy  in 
the  Earning  Poicer  of  Railroads.  (Issued  annually.)  These  ratios  are 
computed  for  each  railroad. 


290  INVESTMENT  ANALYSIS 

The  other  two  charges  are  constant  and  can  be  known  from  year 
to  year,  so  that  a  bondholder,  after  he  has  made  his  analysis 
of  operating,  may  always  know  what  the  strength  of  his 
equity  on  the  basis  of  earnings  is.  In  some  cases,  savings  can  be 
anticipated  and  a  consequent  strengthening  of  this  equity  can 
be  made  by  the  issuance  of  refunding  issues  with  the  idea  of 
refunding  these  bonds  in  the  near  future  at  a  lower  rate  of 
interest.  Guaranteed  dividends,  which  are  usually  on  leased 
properties,  can  also  be  placed  in  the  same  general  classification 
as  interest  charges  as  far  as  the  effect  on  net  profits.  If  sub- 
sidiary properties  are  involved,  the  investor  should  note  whether 
all  interest  charges  for  the  fiscal  year  have  been  recorded  in 
their  final  accounts.  Amortization  charges  and  sinking  fund 
accounts  have  dropped  into  relative  insignificance  in  recent 
years.  As  Mr.  Chamberlain  states,  "experience  has  demon- 
strated that  money  is  more  wisely  appropriated  if  it  is  not 
sequestered  in  special  funds,  but  is  returned  immediately  to 
the  road  in  heavier  maintenance,  or  more  extensive  improve- 
ments, with  trust  in  the  increased  earning  and  better  credit  thus 
acquired,  to  refund  the  issue  at  maturity  in  a  general  scheme 
of  debt  consolidation.  But  it  does  not  apply  to  bond  issues — 
which  do  not  create  a  permanently  greater  earning  capacity." 
The  more  notable  exceptions  which  should  be  amortized  are  the 
car-trust  issues,  which  are  discussed  at  length  in  Chapter  XVII. 
The  net  corporate  income  is  the  net  profit  that  is  left 
after  deducting  all  previous  charges  mentioned.  This  is  a  fund 
which  the  directors  may  divide  and  distribute  as  dividends,  or 
place  in  the  property  account,  as  they  may  rule.  While  the 
operating  expense  accounts  may  not  have  been  adequately  main- 
tained, the  net  surplus  is  entirely  at  the  disposal  of  the  officials. 
It  is  apparent,  then,  why  it  is  so  dangerous  to  place  so  much 
emphasis  upon  the  surplus  accounts,  without  the  proper  exam- 
ination of  all  corporation  accounts.  Too  often,  in  the  past,  sur- 
plus accounts  have  existed  where  deficits  or  near  deficits  would 
have  existed  if  the  principle  of  sound  maintenance  of  prop- 
erties had  not  been  violated.  If  all  previous  accounts  have 

'Lawrence    Chamberlain,    Principles    of  Bond,   Investment    (1911). 
p.  275. 


RAILROAD  BONDS  291 

been  maintained,  the  average  current  surplus  per  year  should 
represent  the  investment  strength  of  the  railroad's  securities. 
*  This  does  not  mean  that  a  greater  absolute  amount  or  a 
erreater  amount  of  surplus  per  mile  necessarily  indicates  greater 
safety  of  one  railroad  over  another.  Nevertheless,  where  a  rail- 
road possesses  a  larger  comparative  amount  of  surplus  than 
another  railroad  it  is  commonly  accepted  as  indicating  greater 
strength,  and  this  is  even  more  true  than  the  same  kind  of 
general  conclusions  used  in  analyzing  net  operating  revenue. 
These  conclusions  are,  however,  only  the  normal  result  of  much 
of  the  prevalent  loose  analysis  of  railroad  securities.  Large 
surpluses  are  desirable,  but  other  things  must  be  equal. 

Distribution  of  the  Current  Surplus. — As  stated  in  the 
previous  topic,  the  excess  of  surplus  of  one  road  over  another 
indicates  superior  strength  only  in  so  far  as  the  other  items  of 
the  income  statement  show  a  corresponding  strength.  The  chief 
dispositions  that  may  be  made  of  surplus  are  either  to  place  it 
directly  back  into  the  properties,  or  to  credit  it  to  profit  and 
loss.  The  policy  of  American  railroads,  in  the  disposition  of 
the  surplus,  has  been  decidedly  more  conservative  than  that 
of  industrials.  A  very  large  amount  has  continually  been 
placed  back  into  property.  "Where  the  policy  of  placing  large 
proportions  of  surplus  back  into  property  has  been  consistently 
followed,  it  has  meant  a  conservative  dividend  policy,  which,  in 
turn,  has  been  reflected  in  the  ultimate  increase  of  property 
values.  Again,  the  comparative  importance  of  the  appropriated 
surplus  account  depends  upon  what  amount  has  originally  been 
placed  in  maintenance  accounts.  If  the  latter  accounts  have 
not  been  sufficiently  imbursed,  the  "appropriated  surplus"  is 
of  less  importance.  Before  the  Interstate  Commerce  Commis- 
sion adopted  its  present  requirement  of  charging  direct  to 
maintenance  accounts  all  funds  so  appropriated,  it  was  not  an 
infrequent  practice  for  a  railroad,  in  order  to  make  a  good 
showing,  to  "skim"  maintenance  accounts  for  the  purpose  of 
increasing  the  surplus  account  for  the  year.  If  the  road  paid 
a  small  part  of  this  surplus  for  the  year  in  dividends,  it  would 
appear  from  the  examination  of  the  net  revenues  alone,  that 
the  road  was  following  a  conservative  policy.  An  examination 


292  INVESTMENT  ANALYSIS 

of  the  operating  accounts,  however,  would  reveal  that  the  con- 
trary was  true.  This  was  purely  a  bookkeeping  subterfuge. 
Some  railroads  which  showed  a  respectable  current  surplus, 
under  these  conditions,  were  forced  to  borrow  within  the  same 
year. 

Even  with  consistently  steady  net  profits  from  year  to  year, 
a  railroad  is  never  justified  in  paying  these  profits  all  out  in 
dividends.  A  road  which  has  retained  a  certain  amount  of  its 
surplus  every  year,  places  itself  in  such  a  strong  position  that 
it  will  not  generally  be  forced  to  borrow  in  a  temporarily  high 
and  strained  market.  Neither  is  the  corporation,  as  long  as  a 
portion  of  the  surplus  is  placed  back  into  the  properties,  forced 
to  make  large  increases  in  its  capital  obligations,  and  conse- 
quently its  borrowing  power  is  strengthened. 


CHAPTER  XVI 

RAILROAD  BONDS :   THE  BALANCE  SHEET  AND 
CAPITAL  ACCOUNTS 

The  railroad  balance  sheet  presents  a  summation  of  assets 
and  liabilities  with  their  respective  valuations  on  a  given  date. 
Historically,  it  gives  the  cumulative  results  in  property  accounts 
since  the  organization  of  the  railroad.  In  this  latter,  the  dis- 
tinction between  the  different  kinds  of  assets  and  liabilities 
extends  beyond  the  mere  portrayal  of  the  individual  items  in. 
the  statement.  Because  of  the  large  amount  invested  in  the 
fixed  property  of  railroads,  there  is  a  particular  interest  to  the 
bondholder  in  the  study  of  the  balance  sheet.  The  balance  sheet 
items  are,  however,  of  real  value  only  when  used  in  conjunc- 
tion with  the  income  statement. 

The  Condensed  Balance  Sheet  following,  is  the  form  pre- 
scribed by  the  Interstate  Commerce  Commission.  The  policy 
of  separating  the  operating  properties  is  followed  in  the  bal- 
ance sheet,  as  in  the  separation  of  the  income  from  the  various 
sources  in  the  Income  Statement.  The  assets  of  the  General 
Balance  Sheet  are  divided  into  the  main  headings:  (1)  Prop- 
erty Investment;  (2)  Working  Assets;  (3)  Accrued  Income  Not 
Due,  and  (4)  Deferred  Debt  Items;  and  the  liabilities  into: 
(1)  Capital  Stocks;  (2)  Mortgage,  Bonded  and  Secured  Debts; 
(3)  Working  Liabilities;  (4)  Accrued  Liabilities  Not  Due;  (5) 
Deferred  Credit  Items;  (6)  Appropriated  Surplus,  and  (7) 
Profit  and  Loss.  The  more  important  divisions  under  these 
headings  will  be  given  as  the  discussion  of  the  balance  sheet 
proceeds.1 


*As  stated  elsewhere  a  complete  and  detailed  report  of  any  railroad 
system  may  be  obtained  from  the  Secretary  of  the  Interstate  Commerce 
Commission  for  a  nominal  sum. 

293 


294 


INVESTMENT  ANALYSIS 


ANNUAL  REPORT 
CONDENSED  GENERAL  BALANCE  SHEET,  DECEMBER  31,  1917 

ASSETS 

THE  NEW  YORK  CENTRAL  RAILROAD  COMPANY 
INVESTMENTS  : 

Investment  in  road $460,514,249.12 

Investment  in  equipment : 

Trust    95,106,669.96 

Other   138,998,261.64 

$694,619,180.72 
Improvem'ts  on  leased  r'way  property  92,132,201.72 

Miscellaneous  physical  property 8,680.603.82 

Investments  in  affiliated  companies : 

Stocks    $133,799,976.96 

Bonds    9,952,035.88 

Notes    36,266,355.57 

Advances    14,516,500.80 

194,534,869.21 
Other  investments : 

Stocks   $  31,139,974.32 

Bonds    1,046,544.52 

Notes    11,480,026.03 

Advances    750,039.12 

Miscellaneous    12,765.00 

44,429,348.99 

Total  investments   $1,034,396,204.4(5 

CURRENT  ASSETS  : 

Cash    $  13,407,045.26 

Special  deposits 934,098.51 

Loans  and  bills  receivable 43,960.22 

Traffic  &  car-service  balances  rec'v'ble  6,514,277.27 
Net  balance  due  from  agents  and  con- 
ductors      9,616,893.84 

Miscellaneous    accounts   receivable. . .  16,131,617.97 

Material  and  supplies 34,239,829.70 

Interest  and  dividends  receivable 3,405,282.19 

Other  currents  assets 534,840.31 

84,827,845.27 
DEFERRED  ASSETS  : 

Working  fund  advances $       201,715.87 

Insurance  and  other  funds 727,893.45 

Other  deferred  assets 4,749,890.72 

5,679,500.04 


RAILROAD  BONDS 

UNADJUSTED  DEBITS  : 
Rents   and   insurance  premiums   paid 

in  advance $  37,769.17 

Discount  on  funded  debt  unamortized  6,883,107.79 

Other  unadjusted  debits 5,289,656.94 

Securities  issued  or  assum'd — unpl'd'g'd  730,000.00 
Securities  issued  or  assum'd — pledged  20,500,000.00 
Securities  acquired  from  lessor  com- 
panies  (per  contra)    457,851.00 


295 


33,898,384.90 
$1,158,801,934.67 

THE  NEW  YORK  CENTRAL  RAILROAD  COMPANY 
CONDENSED   GENERAL   BALANCE    SHEET,   DECEMBER   31,   1917 

LIABILITIES—  ( Continued ) 
STOCK  : 

Capital  Stock $249,849,360.00 

LONG  TERM  DEBT  : 

Nominally 
Funded  debt  unmatured  :         Issued 

Equipment  obligations. $1.21S,OOO.CO     $^4,802,086.19 

Mortgage  bonds 20.000,000.00     546,581,000.00 

Debentures   105,500,000,00 

Notes   15,000,000.00 

711,883,086.19 
CURRENT  LIABILITIES  : 

Loans  and  bills  payable $17,302,450.00 

Traffic  &  car-service  balances  payable  6,330,806.54 

Audited  accounts  and  wages  payable.  18,144,635.24 

Miscellaneous  accounts  payable 7,161,505.47 

Interest  matured  unpaid : 
Matured,    payable 

Jan.  1,  1918 $2,926,772.38 

Interest  unclaimed 33,465.85 

2,960,238.23 

Dividend  declared,  payable  Feb.1,1918  3,119,902.50 

Dividends  matured  unclaimed 186,635.05 

Funded  debt  matured  unpaid 4,790.00 

Unmatured  interest  accrued 5,544,260.35 

Unmatured  rents  accrued 824,329.50 

Other  current  liabilities 2,275,557.56 


83,855,110.44 


296 


INVESTMENT  ANALYSIS 


DEFEBBED  LIABILITIES: 
Liability     to    lessor     companies    for 

equipment    $14,715,322.52 

Miscellaneous   569,541.50 

15,284,864.02 
UNADJUSTED  CREDITS  : 

Tax  liability  $  3,567,909.53 

Insurance  and  casualty  reserves 580,065.50 

Operating  reserves    1,192,914.99 

Accrued  depreciation  of  equipment. .  33,159,007.29 
Liability  to  lessor  companies  for  se- 
curities acquired   (per  contra)....  457,851.00 
Other  unadjusted  credits 3,168,016.65 

42,125,764.96 
CORPORATE  SURPLUS  : 
Additions  to  property  through  income 

and  surplus  $        93,628.85 

Sinking  fund  reserves 464,918.47 

Total  appropriated   surplus $      558,547.32 

Profit  and  loss — credit  balance 75,245,201.74 


75,803,749.06 
$1,158,801,934.67 

The  Property  Account. — As  referred  to  under  the  subse- 
quent topic  of  Liabilities  and  Capitalization,  it  is  essential  that 
itemized  accounts  representing  the  accumulation  of  property 
accounts,  as  originally  entered,  shall  be  retained  in  the  state- 
ment to  give  the  true  fiscal  changes  which  take  place  from  year 
to  year.  To  the  security  holder,  however,  bookkeeping  entries 
are  of  interest  only  in  so  far  as  they  can  be  used  in  determin- 
ing what  valuation  can  be  placed  upon  the  property  account 
back  of  his  holdings. 

Property  Investments  include  the  chief  headings  of:  (1) 
Road  and  Equipment;  (2)  Securities;  (3)  Other  Investments, 
and  (4)  Miscellaneous  Investments.  The  first  of  these,  and  by 
far  the  largest,  is  Road  and  Equipment.  Prior  to  the  required 
separation  of  the  Road  and  Equipment  accounts  required  by 
the  Interstate  Commerce  Commission  in  1907,  the  property 
accounts  of  different  roads  represented  entirely  different  things. 


RAILROAD  BONDS  297 

There  was  always  a  temptation  to  the  weaker  companies  to 
utilize  this  opportunity  to  make  a  stronger  showing  for  their 
property  accounts.  The  required  creation,  also,  of  the  ' '  Reserve 
for  Accrued  Depreciation"  (for  equipment  in  1907  and  all 
properties  in  1918)  which  many  companies  had  not  carried, 
made  it  possible  to  estimate  property  values,  if  the  property 
values  on  the  basis  year  of  1908  and  1919  were  correctly  en- 
tered. Prior  to  1918,  several  of  the  more  profitable  systems  had 
charged  new  construction  to  operating  expense,  a  practice  which 
made  no  increase  in  the  property  investment  account,  though 
the  value  of  the  railroad's  property  holdings  was  much 
stronger.1  "Weak  systems  followed  the  contrary  policy  of  fail- 
ing to  write  off  proper  losses  for  direct  depreciation,  the  aban- 
donment of  property,  or  obsolescence.2  The  railroad  accounts 
then  represented  a  surcharging  of  maintenance  which  the 
accounts  did  not  show.  To  compare  two  roads  under  these 
conditions  would  be  comparing  two  different  things. 

Fixed  assets,  as  with  other  railroad  accounts,  can  be  best 
measured  by  reducing  these  accounts  to  the  mile  unit  base. 
But,  as  with  any  unit  of  measurement,  this  must  be  used  with 
qualification.  No  unqualified  standard  of  measurement  for 
property  investment  will  ever  be  found,  as  no  two  railroads, 
even  with  equal  mileage,  are  operating  under  the  same  condi- 
tions. Two  railroads  may  have  the  same  amount  of  traffic,  but 
if  one  is  operating  through  a  mountainous  country  and  the 
other  through  level  territory,  it  would  make  a  comparison  of 
the  fixed  investment  per  mile,  the  most  common  unit  of  meas- 
urement worthless.  One  railroad  may  have  its  own  termi- 
nals, while  the  other  does  not.  This  makes  the  investment  per 
mile  of  the  one  railroad  much  higher  than  that  of  the  other. 
One  railroad  may  have  deliberately  invested  a  very  much  larger 
amount  in  fixed  property,  and  yet  secured  a  very  much  larger 
return  on  its  investment  than  the  other  road  because  of  the 
lower  operating  expenses  resulting  from  this  investment.  One 

'See  /.  C.  C.,  vol.  xxix,  pp.  508,  515  (The  Chicago,  Milwaukee  and  St. 
Paul  case  in  connection  with  the  Puget  Sound  extension  offers  some  inter- 
esting side-lights  on  what  can,  without  legal  violation,  be  hidden  or 
omitted  in  an  account). 

2Homer  Bews  Vanderblue,  Railroad  Valuation,  pp.  113-117  (1917). 


298  INVESTMENT  ANALYSIS 

railroad  might  own  a  very  much  larger  amount  of  its  equip- 
ment and  the  other  would  have  to  pay  larger  rentals  or  interest 
charges. 

Some  analysts  fail  to  make  any  distinction  between  the  road 
which  owns  its  total  mileage  outright  and  the  company  which 
leases  or  controls,  through  stock  ownership,  the  larger  part  of 
its  mileage.  AVhere  a  large  part  of  the  property  operated  is  of 
either  of  the  latter  forms,  the  transferring  of  this  account  from 
the  property  account  to  the  account  of  securities  owned  would 
make  a  material  difference  in  the  comparison.  It  is,  of  course,  a 
mere  difference  in  bookkeeping,  for  the  value  of  the  road  is 
just  the  same.  It  does,  however,  destroy  the  value  of  a  mileage 
measurement,  unless  these  qualifications  are  properly  weighed. 
This  kind  of  standardization,  as  frequently  suggested  in  these 
pages,  is  merely  to  simplify  the  method  of  analysis  and  make 
the  interpretation  more  simple.  The  analysis  of  a  railroad,  at 
best,  is  complex,  and  the  simpler  the  forms  can  be  kept  and  yet 
reveal  the  correct  results,  the  less  opportunity  there  is  for 
errors  of  interpretation. 

A  check  upon  the  property  accounts  over  a  series  of  years 
should  reveal  in  the  comparative  examination  of  the  accounts, 
where  the  expenditures  upon  property  have  been  made  and  how 
any  increase  compares  with  the  general  growth,  if  any,  of  the 
system.  By  a  comparison  of  these  accounts  with  the  income 
statements  covering  the  same  period,  the  character  and  the 
sources  of  the  appropriations  to  construction  accounts  can  be 
determined.  The  character  of  these  disbursements  is  also  an- 
other check  upon  the  conservative  or  non-conservative  mana- 
gerial policy  of  the  railroad.  With  the  detailed  items,  now 
required  by  the  Interstate  Commerce  Commission,  it  is  possible 
to  obtain  these  results  with  a  considerable  degree  of  accuracy, 
though  not  for  the  period  prior  to  1908. 

Investment  securities  include  those  investments  which  have 
been  directly  issued  on  subsidiaries  owned,  securities  of  sub- 
sidiaries that  have  been  assumed,  and  those  of  outside  corpora- 
tions. These  again  are  divided  into  two  classes,  those  that  are 
held  in  the  treasury  of  the  railroad  for  investment  and  those 
which  are  deposited,  as  collateral,  for  loans.  From  the  stand- 


EAILKOAD  BONDS  299 

point  of  the  property  accounts,  there  are  three  questions  which 
arise  concerning  these  investments.  First,  does  the  book  value 
of  these  securities  as  carried  in  the  accounts  represent  the 
market  value  of  these  holdings?  Second,  are  all  the  securities 
owned  deposited  as  collateral  so  that  no  further  credit  is  avail- 
able upon  these  holdings?  Third,  are  security  and  stability  of 
the  dividend  or  interest  from  these  securities  assured?  It  has 
been  a  not  uncommon  practice  to  carry  these  securities  in  the 
balance  sheet  at  a  greatly  over-valued  figure,  when  compared 
with  their  actual  market  value.  This  results  in  a  corresponding 
inflation.1  As  a  matter  of  fact  the  item  investment  in  the  bal- 
ance sheet  may  conceal  a  great  deal — it  usually  does.  Take 
the  case  of  the  Alabama  and  Great  Southern,  one  of  the  sub- 
sidiaries of  the  Southern  Railway  and  an  extremely  valuable 
property.  The  latter  road  carries  this  subsidiary  property  at  a 
little  over  $1,000,000.  Included  in  this  is  ownership  of  about 
$1,000,000  Cincinnati,  New  Orleans  and  Texas  Pacific  Stock 
which  is  worth  approximately  $2,000,000  alone.  On  the  other 
hand,  the  New  Haven  Railroad  carries  on  its  balance  sheets 
various  investments,  especially  the  street  railway  properties,  in 
many  cases  at  a  price  of  par  or  over  for  the  stock  which  is  at 
present  far  under  this  valuation. 

As  stated  under  Other  Income,  while  the  direct  earnings 
of  the  controlled  subsidiary  show  a  deficit,  they  may  have  a  very 
material  effect  on  the  total  earnings  of  the  holding  company. 
For  example,  in  the  joint  control  of  terminals,  the  earnings 
might  show  an  actual  deficit  on  the  terminal  corporation,  but 
what  could  the  railroad  do  without  terminals  ? 2 

The  miscellaneous  investments,  with  few  exceptions,  are  not 
generally  very  important.  The  separation  of  the  former  coal 
holdings  of  some  of  the  railroads  from  their  own  holdings,  as 
required  by  the  commodities  clause,  has  reduced  this  item  to  a 
considerable  extent  for  a  number  of  the  so-called  coal  railroads. 
Where  the  railroad  possesses  or  leases  other  property,  it 


*/.  C.  C.,  vol.  xxix,  pp.  139  seq. — Illustration  of  security  inflation  in 
subsidiary  security  holdings  are  to  be  found  in  the  receivership  case  of 
the  San  Francisco  Railroad  Company. 

2/.  C.  C.,  vol.  xliv,  pp.  1-223  (Pere  Marquette  Case). 


300  INVESTMENT  ANALYSIS 

is  not  required  to  publish  any  facts  concerning  the  operation 
of  this  property,  so  that  the  holder  of  the  railroad  security  may 
be  left  entirely  in  the  dark  as  to  the  value  of  these  holdings 
to  the  company,  unless  the  board  of  directors  desires  to  make 
the  facts  public.  No  analysis  of  a  railroad  can  be  complete 
without  this  information,  though  its  importance  varies  with 
the  amount  of  the  property  held.  And  if  there  is  danger  of 
its  becoming  an  opening  into  which  funds  might  be  poured, 
the  process  might  not  only  be  costly  but  result  in  very  large 
losses,  as  has  been  experienced  by  some  railroads.1 

Current  Accounts. — Though  the  current  accounts  are  in  a 
very  small  ratio  to  the  fixed  assets  of  a  railroad,  they  may  be 
measurably  more  important,  especially  in  relation  to  the  pay- 
ment of  fixed  charges.  If  a  railroad  is  not  able  to  pay  its 
interest  charges  on  the  date  that  they  fall  due,  foreclosure  is 
inevitable,  unless  extensions  can  be  secured  or  additional  loans 
can  be  made.  Additional  loans,  however,  are  not  only  undesir- 
able, but  often  impossible,  and  as  far  as  the  future  is  concerned 
they  only  increase  the  burden.  The  cash  account,  therefore,  is 
the  most  important  single  item  in  the  current  accounts.  Cur- 
rent items,  of  course,  that  can  be  readily  turned  into  cash,  will 
furnish  relief  in  case  of  necessity.  As  the  larger  part  of  the 
revenue  of  railroads  is  in  the  form  of  cash  transactions,  there  is 
never  a  very  large  amount  from  other  sources  that  can  be 
turned  into  cash.  Materials  and  inventories  accounts  gen- 
erally need  be  given  little  consideration,  as  they  must  be  used 
for  the  railroads'  own  immediate  replacements  and  repairs.  A 
large  account  in  materials,  however,  would  signify  that  the 
expenditures  for  materials  could  be  curtailed  for  a  short  period, 
at  least,  and  the*  maintenance  accounts  not  suffer. 

A  separation  should  be  made  between  those  receivable 
accounts  which  are  due  from  a  railroad's  own  subsidiaries  and 
the  receivable  accounts  due  from  other  outside  sources.  Receiv- 
ables due  to  a  railroad  from  its  subsidiaries  might  even  be  in 
the  form  of  advances  for  interest  and  maintenance  charges.  A 
large  amount  of  receivables  of  this  character  are  often  con- 


1l.  C.  C.,  vol.  xxvii,  pp.  560  seq. — The  New  England  Investigation. 
(The  Weakness  brought  out  in  the  Boston  and  Maine  is  applicable.) 


RAILROAD  BONDS  301 

tinned  obligations,  and  if  the  subsidiary  road  is  ever  to  pay 
these  debts,  it  may  be  forced  to  fund  these  current  obligations. 
Under  the  old  forms,  or  lack  of  forms,  of  unregulated  reports, 
it  was  a  comparatively  easy  matter  to  shift  the  accounts  of  this 
character.  Where  receivables  are  from  outside  sources,  they 
are  of  very  small  amounts,  of  very  short  duration,  easily  col- 
lected, and  never  give  serious  concern. 

Liabilities  and  Capitalization. — The  liability  accounts  are: 
(1)  Capital  Liabilities;  (2)  Working  Liabilities;  (3)  Accrued 
Liabilities  Not  Due ;  (4)  Deferred  Credit  Items;  (5)  Appropri- 
ated Surplus,  which  includes  the  balance  of  Profit  and  Loss 
(for  the  year).  The  most  important  of  the  above  is  Capital 
Liabilities.  Any  discussion  of  Capital  Liabilities,  in  order  to 
avoid  many  of  the  confusions  growing  out  of  an  examination  of 
capitalization,  must  distinguish  between  capital  and  capital 
liabilities,  as  has  been  previously  mentioned.  Capitalization, 
which  is  the  total  amount  of  paper  evidence  of  obligations 
issued,  does  not  necessarily  represent  the  same  thing  as  capital, 
which  represents  tangible  property.  The  latter  may  be  much 
greater  or  much  less  than  the  security  liabilities  of  the  corpora- 
tion. If  maintenance  and  depreciation  have  been  amply  cov- 
ered and  a  large  amount  from  surplus  earnings  placed  back 
into  the  property,  the  capital  account  will  be  a  very  much  larger 
amount  than  the  capitalization,  i.  e.,  the  par  value  of  the  securi- 
ties outstanding.  On  the  other  hand,  if  the  property  is  allowed 
to  deteriorate,  or  the  tangible  property  is  overhauled,  and  the 
securities  issued  to  the  amount  of  this  valuation,  the  capital 
amount  will  not  be  less  than  the  capitalization.  In  other  words, 
the  par  value  of  the  outstanding  securities  will  be  much  more 
than  the  actual  value  of  the  property  account.  In  the  long 
run,  however,  these  variations  between  capital  and  capitaliza- 
tion are  reflected  in  the  price  of  railroad  securities. 

Capital  liabilities  are  divided  into  capital  stock,  mortgages, 
bonds,  and  notes.  The  prevalent  stock  issues  are  the  preferred 
and  common  stock  issues,  though  a  number  of  old  issues  known 
as  guaranteed  stock,  which  may  be  either  one  of  the  former 
stock  issues  guaranteed  by  a  second  corporation,  usually  a 
parent  company,  are  still  outstanding.  A  few  special  types  of 


302  INVESTMENT  ANALYSIS 

capital  stock,  whose  complete  financial  status  must  be  procured 
from  the  individual  reports  or  records  of  the  company,  are  to 
be  found  among  the  older  issues. 

Preferred  stock  issues  steadily  increased  from  1890  to  1898, 
during  the  period  of  railroad  reorganization,  when  railroads 
were  forced  to  reduce  their  interest  charges.1  Since  1900,  how- 
ever, the  use  of  preferred  stock  by  railroads  has  declined.  This 
decline  in  some  large  measure  was  due  to  the  increased  rates 
offered  by  other  public  utilities  and  industrials  on  their  pre- 
ferred stock  issues.  Eailroads  could  not  profitably  compete 
with  these  higher  rates  and  so  resorted  to  bond  issues.  With 
the  influence  of  the  higher  interest  rates  which  must  now  be 
paid  for  money  together  with  the  Federal  taxes,  preferred  stock 
issues  will  increase  in  the  future.  This  is  already  evidenced  in 
the  issue  of  preferred  stocks  in  recent  receivership  organiza- 
tions. Modification,  however,  will  be  found  in  the  railroad  pre- 
ferred  stock  regulations  from  the  elaborate  regulations  still 
attached  to  some  preferred  stock  issues  of  industrials,  many 
of  which  are  of  no  importance. 

Railroad  bonds  offer  the  most  perplexing  problem,  not  only 
in  railroad  financial  statements,  but  in  all  corporate  loans.  If 
all  the  credit  obligations  of  a  railroad  were  in  two  or  three  dif- 
ferent bond  issues  with  a  first,  second,  and  third  lieu  against 
all  properties  of  the  railroad,  the  problem  of  credit  obligations 
would  be  relatively  simple.2  But  with  the  intricacies  in  the 
corporate  relationships  which  have  been  built  up  through  the 
use  of  construction  companies,  holding  companies,  mergers,  con- 
solidations and  guarantees,  creditors'  claims  and  liens  are, 
indeed,  complicated  ones.  The  total  aggregate  burden  of  these 
obligations  upon  the  mileage  of  a  railroad  can  be  best  tested 
by  reducing  the  total  obligations  to  a  per  mile  basis.  A  com- 
plete knowledge  of  the  burden  of  these  obligations,  coupled  with 

Stuart  Daggett,  Railroad  Reorganisation  (1908).  A  study  of  the  re- 
ceiverships in  this  volume  gives  a  number  of  illustrations  of  this  increase 
of  preferred  stock  issues. 

2The  White  and  Kemble's  Atlas  and  Digest  of  Railroad  Mortgages, 
gives  the  complete  details  o°  the  mortgage  lien  in  graphic  form,  which 
very  much  simplifies  the  complicated  details  of  the  railroad  mortgage 
Accompanying  these  maps  is  a  copy  of  the  mortgage  instrument. 


RAILROAD  BONDS  303 

the  analysis  of  its  net  earning  power,  indicates  the  railroad's 
ability  as  a  going  concern,  as  well  as  its  potential  possibilities 
for  the  future. 

"While  the  claims  of  a  particular  security  cannot  be  isolated 
from  the  aggregated  obligations  of  the  company,  as  a  going 
concern,  the  priority  in  the  claim  of  an  individual  issue  does 
give  an  advantage  in  forfeitures  of  the  company's  own  claims. 
It  is  for  this  reason  that  the  first  mortgage  bond  will  sell  at  a 
premium  and  a  third  mortgage  may  sell  at  a  discount,  even  where 
both  bond  issues  are  on  exactly  the  same  mileage.  If  the  lien 
of  a  single  issue  is,  for  illustration,  a  first  lien  on  a  part  of  the 
main  line  mileage,  a  second  lien  on  the  remainder  and  a  third 
lien  on  some  branch  line,  what  is  the  exact  value  of  the  holder's 
claims?  Again,  a  debenture  bond  upon  one  railroad  is  often 
more  desirable  than  a  first  mortgage  upon  another  system.  It 
is  the  equity  which  the  security  possesses,  as  well  as  the  value 
of  the  mileage  and  property  covered  by  the  mortgage  that  must 
determine  the  value  of  the  claim. 

The  variations  in  these  liens  are  illustrated  in  the  two  mort- 
gage maps  of  the  Buffalo,  Rochester  and  Pittsburg  Railway  and 
the  Florida  East  Coast  Railway.1  In  the  mortgages  of  the  for- 
mer railroad,  the  consolidated  4^s  of  1957  are  a  good  illustra- 
tion of  several  different  liens  under  a  single  mortgage.  The 
only  difference  between  this  particular  mortgage  and  a  trunk 
line  is  that  the  latter  will  generally  represent  a  greater  mileage. 
In  the  Florida  East  Coast  Railway  is  represented  one  of  the 
simplest  mortgage  structures.  Trunk  lines,  of  course,  will  not 
show  as  simple  a  structure  as  this  latter  system.  The  keys  to 
the  maps  are  self-explanatory. 


'The  two  railroad  mortgage  maps  cited  were  selected  because  of  their 
simplicity  and  compactness.  These  two  mortgage  maps,  however,  repre- 
sent the  two  contrasts  as  well  as  the  more  complicated  and  larger  maps 
of  the  trunk-line  systems.  The  purpose  in  the  use  of  these  maps  is  to 
bring  out  the  difference  in  the  character  of  liens.  These  maps  are  taken 
from  the  plates  of  the  Kimber  Railroad  Mortgage  Map  Atlas  through  the 
courtesy  of  Mr.  A.  W.  Kimber. 

The  student  will  find  railroad  mortgage  maps  invaluable.  He  will 
find  his  study  not  only  much  simplified  as  far  as  a  real  understanding  of 
liens  but  infinitely  more  accurate. 


BUFFALO,  ROCHESTER  &  PITTSBURGH  RAILWAY 


NOTE — In   combinations    of   symbols    the   heavy    symbols 
represent  first  or  underlying  liens. 


Buffalo,  Rochester  &  Pittsburgh  Gen.  5s,  1937 «  AA 

1st    lien  on     19  miles 

2nd  lien  on  125  miles 

3rd   lien  on  109  miles 

Also  secured  by  1st  lien  on  practically  entire 

capital  stock  of  Rochester  &  Pittsburgh  Coal  & 

Iron  Co. 

Authorized  :  $4,780,000.    Outstanding :  $4,427,000. 

Do    Cons.  V/2s,  1957. <• 

1st    lien  on  105  miles 

2nd  lien  on    29  miles 

3rd   lien  on  125  miles 

4th    lien  on  109  miles 

Also  secured  upon  $249,700  (total  issue  $500,000) 

capital  stock  of  Lake  Ontario  Ferry  Co.,  Ltd. 

Also  secured  on  99  miles  of  leaseholds  and  131 

miles  trackage  rights. 

Authorized  :  $35,000,000.  Outstanding :  $16,414,000. 

Allegheny  &  Western  1st  4s,  1998 •  + 

1st  lien  on  62  miles,  including  branches. 
Guaranteed   principal   and   interest   by   Buffalo, 
Rochester  &  Pittsburgh  Ry.  Co.  by  endorsement. 
Closed  Mortgage.    Outstanding :  $2,000,000. 

Clearfield  &  Mahoning  1st  5s,  1943 DEZXXZXEX 

1st  lien  on  26  miles 

Guaranteed  principal  and  interest  by  Buffalo, 
Rochester  &  Pittsburgh  Ry.  Co.  by  endorsement. 
Authorized  and  outstanding :  $050,000. 

Lincoln  Park  &  Charlotte   1st  5s,    1939 ******** 

1st  lien  on  10  miles 

Guaranteed  principal  and  interest  by  Buffalo, 
Rochester  &  Pittsburgh  Ry.  Co.  by  endorsement. 
Authorized  and  outstanding:  $350,000. 

Mahoning  Valley  R.  R.     No  Mortgage 

Leased  in  perpetuity  to  Buffalo,  Rochester  & 
Pittsburgh  Ry.  Co. 

Rochester  &  Pittsburgh  1st  6s,  1921 CXSZXXXZS 

1st  lien  on  109  miles 

Assumed  by  B.,  R.  &  P.  Ry.  Co. 

Closed  Mortgage.     Outstanding:  $1,300,000. 

Do    Cons.  1st  6s,  1922 •!§•••§* 

1st  lien  on  125  miles 

2nd  lien  on  109  miles 

Assumed  by  B..  R.  &  P.  Ry.  Co. 

Closed  Mortgage.    Outstanding :  $3,920,000. 

Copyright,    1920   by 

A.  W.  KIMBER  &  CO.,  Inc. 


r--   N  EUN     ^mn  o 


P      !£   /1si      N      5     ^$    L      V      A;    N 

'       -'  .*'       «4  .'  x 


Kimber's  Mortgage  Map 

of  the 

BUFFALO.  ROCHESTER 
Se.  PITTSBURGH  RY. 


OOPYIOCHT  1410  BY  A.  W  KIMBER  S  CD.  INC. 


FLORIDA  EAST   COAST  RAILWAY 


Florida  East  Coast  1st  454s,  1959 

1st  lien  oil  617  miles  and  equipment 
Also  secured  by  pledge  of  following : 

Securities  Deposited    Issued 

Atlantic  &  East  Coast  Term. 

Ry.  Co $12,500     $  25,000 

Jacksonville  Term.  Co 49,800      200,000 

Authorized  and  outstanding:  $12,000,000. 


Do    Gen.  Income  Bonds  1959 [ 

2nd  lien  on  617  miles 

Authorized    and    outstanding:    $25,000,000,    all 

owned  by  H.  M.  Flagler  estate. 


Tampa  &  Jacksonville  Ry.  1st  5s,  1949 

1st  lien  on  56  miles 

Authorized :  $10,000  per  mile  of  road. 

Outstanding:  $480,000. 

Tampa  &  Gulf  Coast  R.  R.  1st  5s,  1953 

1st  lien  on  79  miles 

Further  secured  by  pledge  of  50-year  traffic 
agreement  with  Tampa  Northern  R.  R.  giving 
company  entrance  into  Tampa  and  use  of  Tampa 
terminals. 

Guaranteed  principal   and   interest  by   endorse- 
ment by  Seaboard  Air  Line  Ry.  Co. 
Authorized  :  $5,000,000.    Outstanding  :  $750,000. 


Copyright,    1920   by 

A.  W.  KIMBER  &  CO.,  Inc. 


Kimber's  Mortgage  Map 
of  the 

FLORIDA  EAST  COAST 
RAILWAV 


TAMPA  &  JACKSONVILLE  RY. 
TAMPA  &  GULF  COAST  R.  R, 


308  INVESTMENT  ANALYSIS 

On  the  other  hand,  to  maintain  that  this  equity  will  be  fully 
recovered  in  foreclosure  is  absurd.  However  successful  a 
receivership  may  be,  junior  liens,  at  least,  are  always  forced  to 
compromise  their  claims.  And  no  one  is  absolutely  assured  of 
his  claims  until  the  highest  court  has  passed  upon  all  creditors' 
claims.  The  easy  success  of  the  railroad  reorganizations  of  the 
nineties  will  never  be  repeated. 

"The  reason  why  the  reorganizations  of  1889  to  1893  were 
successful,"  writes  the  editor  of  the  Railway  Age  Gazette,  "was 
because  during  the  years  that  followed  there  was  a  tremendous 
expansion  in  the  business  of  the  country,  a  wave  of  prosperity 
in  all  lines  of  industry,  and  a  freedom  from  governmental  inter- 
ferences. .  .  .  For  this  reason  a  reorganization  similar  to  that 
of  the  Baltimore  and  Ohio,  or  the  Northern  Pacific,  would  stand 
a  small  chance  of  being  successful  with  the  Wabash  or  the 
Frisco  [speaking  of  the  four  recent  receiverships,  namely:  the 
Wabash,  the  St.  Louis,  and  San  Francisco,  the  Chicago,  Bock 
Island  and  Pacific,  and  the  Missouri  Pacific]. 

"It  is  absolutely  essential,  if  the  success  of  the  reorganiza- 
tion of  the  four  properties  now  in  difficulties  is  to  be  based  on 
anything  more  substantial  than  a  hope  for  good  luck,  that  the 
scaling  down  of  fixed  charges  be  drastic;  that  the  amount  of 
new  capital  to  be  put  into  the  company  be  ample.  .  .  .  Fur- 
thermore, a  very  substantial  margin  of  safety  between  fixed 
charges  and  minimum  earning  charges  must  be  assured." 

The  attitude  of  conservative  interests  is  further  expressed 
in  the  method  of  capitalization  pursued  by  some  of  the  specu- 
lative enterprises.  "Under  no  conceivable  definition  of  the 
word  could  these  stocks  be  considered  investments  at  any  time 
within  the  past  ten  or  fifteen  years.  They  were  speculative 
pure  and  simple,  and  the  speculator  must  be  prepared  to  take 
losses  as  well  as  profits  .  .  .  [the  junior  securities].  This  class 
of  investors  should  be  able  to  take  a  temporary  loss  for  its 
ultimate  gain.  Since  the  only  way  that  these  junior  securities 
can  ever  be  developed  into  good  interest  paying  investments,  is 
by  a  very  complete  change  in  the  theory  on  which  the  roads 
have  been  financed  heretofore,  it  would  appear  that  in  the  long 
run  holders  of  such  securities  would  very  much  benefit  by  sub- 
mitting to  quite  a  severe  present  loss."  This  must  continue 
to  be  the  experience  of  any  over-inflated  securities,  regardless 
of  what  may  develop  in  the  railroad  situation. 


'The  Raihcav  Age  Gazette,  vol.  Ivi,  No.  22  (May  29,  1914)  p.  1174. 


RAILROAD  BONDS  309 

Not  all  of  this  bonded  arid  other  indebtedness  appearing  in 
the  balance  sheet  has  been  directly  created  by  the  railroad  upon 
its  own  properties ;  i.  e.,  there  is  a  distinction  between  bonds  on 
the  company's  own  railroad  property  and  the  investments  in 
other  enterprises.  A  very  considerable  amount  of  railroad  mile- 
age is  also  operated  under  lease,  which  is,  as  far  as  the  operat- 
ing company  is  concerned,  as  much  a  payment  for  the  capital 
as  is  the  payment  of  interest  on  bonds.  The  varying  rates, 
amounts,  and  duration  of  these  leases,  which  are  never  fully 
given  in  railroad  reports,  make  it  difficult  to  capitalize  their 
value.  Under  these  conditions,  it  is  possible  to  capitalize  these 
rentals  only  at  an  arbitrary  rate.  Any  rate  assumed  in  esti- 
mating the  real  investment  value  of  these  leases  should  be  made 
on  the  present  market  rates.  If  the  railroad  is  paying  less 
than  this  rate  for  its  lease,  it  has  that  much  advantage.1 
Where  the  full  information  concerning  these  leases  is  given, 
it  is  a  simple  matter  to  evaluate  them.  This  method  of  evalu- 
ating leases  will  be  found  to  be  more  accurate  than  merely 
adding  the  stocks  and  bonds,  because  of  the  varying  charac- 
ter of  the  leasing  contracts,  unless  sufficient  detail  of  each  con- 
tract is  given  to  capitalize  each  one  separately  and  thus  to  secure 
an  unquestioned  valuation  of  the  total. 

The  gross  capitalization  of  the  railroad,  then,  is  the  sum 
of  its  outstanding  capital  stock,  mortgages,  bonds,  notes,  and  the 
approximate  rent  capitalization  ;2  and  net  capitalization  is  the 
remainder  after  the  deduction  of  the  item  ' '  Securities  Owned, ' ' 
which  renders  an  income  to  the  railroad,  from  the  total  gross 
capitalization.  Where  bonds  are  issued,  but  deposited  as  collat- 
eral, and  notes  are  issued  against  them,  the  amount  added  to 
gross  capitalization  would  be  the  total  of  the  bonds  deposited 
as  collateral.  The  notes  outstanding  would  be  the  net  capitali- 
zation. Neither  should  the  unissued  securities  which  are 
allowed  by  regulation  to  be  carried  at  par  and  to  be  offset  by  a 
current  asset  in  the  balance  sheet  be  included  in  the  net  capi- 

1The  guarantee,  for  example,  of  10  per  cent  on  the  United  New 
Jersey  Railroad  and  Canal  Company  by  the  Pennsylvania  is  really  a 
cheap  guarantee  from  the  point  of  view  of  the  parent  company. 

*If  this  item  is  to  appear  as  a  liability  it  should  also  be  included 
as  a  part  of  the  property  investment  on  the  asset  side. 


310  INVESTMENT  ANALYSIS 

talization.  No  money  has  been  expended  in  the  representation 
of  these  accounts.  They  are  merely  bookkeeping  items;  net 
capitalization  is  a  representation  of  an  actual  capital  invest- 
ment. 

The  magnitude  of  the  investments  of  a  number  of  railroad 
systems  makes  the  value  at  which  they  are  carried  an  important 
influence  on  the  capitalization  of  the  company.  The  legal  limi- 
tations now  placed  upon  these  investments  by  the  Federal  gov- 
ernment have  forced  some  sales  of  former  holdings  of  securi- 
ties, and  the  amendments  to  the  Federal  laws  and  the  adoption 
of  additional  laws  in  1913  will  check  future  investments. 

The  practice  of  carrying  these  securities  at  par,  rather  than 
at  a  fair  market  value,  does  not  give  the  true  value  of  the 
holdings.1  A  subsidiary  company  whose  bonds  are  carried  at 
par  may  have  failed  to  earn  its  interest  charges  for  years, 
regardless  of  what  the  securities  may  have  cost.  No  corpora* 
tion,  or  individual  at  least,  would  be  willing  to  purchase  these 
securities  at  par.  The  value  of  many  of  these  securities  can  be 
obtained  only  through  an  investigation  of  the  individual  prop- 
erties. For  many  of  these  issues  which  have  been  deposited  in 
the  safety  deposit  boxes  of  trustees,  there  has  never  been  any 
general  market  price.  Other  securities  have  never  even  had  a 
market  quotation. 

Upon  one's  first  introduction  to  railroad  capitalization,  the 
wide  range  of  capitalization  seems  inconsistent.9  In  a  few  cor- 
porations, it  is  undoubtedly  inconsistent, — it  is  a  legacy  be- 
queathed by  promoters  with  opulent  optimism,  who  sold  bonds 
at  large  discounts  on  the  basis  of  future  earnings  which  were 
fairy  dreams,  or  the  properties  were  over-capitalized  to  enhance 
the  promoters'  profits.  The  differences  in  the  capitalization  of 
the  railroads  are  justified  on  the  basis  of  the  differences  in  physi- 
cal variation.  Many  of  these  conditions  have  already  been  re- 
ferred to,  such  as  the  differences  in  construction,  etc.,  required 

*See  Morris  and  Essex  Extension  Railroad  (Moody's  Manual,  1917, 
p.  1327). 

*A  comparison  of  the  capitalization  of  railroads  in  the  United  States 
with  the  capitalization  of  English  railroads  will  be  found  interesting  be- 
cause of  the  difference  in  the  accounting  methods :  See  W.  R.  Lawson, 
British  Railroads  (1913),  chaps,  i  and  ii. 


RAILROAD  BONDS  311 

by  the  variation  of  territory  traversed.  Some  systems  have  made 
great  outlays  upon  road  beds,  the  reduction  of  grade  crossings, 
etc.,  by  which  they  have  greatly  reduced  operating  expenses  and 
their  capitalization  is  too  small.1  A  few  systems  have  as  many 
as  four  tracks  on  a  part  of  their  mileage,  and  therefore  have  a 
very  much  higher  cost  of  construction  account  than  does  the 
road  with  a  single  track.  The  difference  between  the  invest- 
ments of  a  railroad  such  as  the  Pennsylvania,  which  owns  exclu- 
sive terminals,  and  a  railroad  which  does  not,  is  often  sufficient 
to  justify  these  differences  in  capitalization. 

One  railroad  might  have  a  much  larger  capitalization  than 
another,  yet  the  burden  of  the  carrying  charges  of  this  obliga- 
tion be  less  than  that  of  a  railroad  with  a  smaller  capitalization ; 
i.  e.,  a  corporation  can  borrow  a  larger  amount  if  it  pays  4 
per  cent  instead  of  5  per  cent,  and  still  be  carrying  the  same 
interest  charge.  Some  of  the  railroads  which  issued  long  tenure 
bonds  at  3  per  cent  will,  as  a  consequence,  be  able  to  continue 
carrying  a  very  much  larger  capitalization  than  railroads  which 
will  be  required  to  refund  a  large  portion  of  their  funded  obli- 
gations in  the  next  few  years.  Consequently,  without  a  close 
examination  of  the  tenures  and  interest  rates  of  the  funded  obli- 
gations, a  study  of  a  railroad's  capitalization  is  incomplete. 

"With  the  necessity  of  increased  charges,  railroads  will  be 
forced  to  increase  their  incomes.  Efficiency  will,  no  doubt,  yield 
some  increase,  but  the  larger  part  must  come  from  an  increase 
in  earnings.  It  is  the  relationship  of  the  latter  to  the  capitali- 
zation which  tells  the  ultimate  story  of  the  safety  of  return  to 
the  investor.  Other  things  being  equal,  the  railroads  with  larger 
capitalization  will  give  a  smaller  margin  on  funded  debt  and 
vice  versa.  Fixed  charges  on  the  road's  mileage  should  not 
take  more  than  one-third  to  one-half  of  the  net  returns  from 
operations.8  While  some  parallelism  in  capitalization  should 
exist  among  systems  operating  in  similar  territories,  this  form 
of  measurement  allows  for  elasticity  without  sacrificing  the  in- 

'Frederick  A.  Cleveland  and  Fred  Wilbur  Powell,  Railroad  Finance 
(1912),  p.  45.  These  authors  state  that  in  most  instances  the  original 
capitalization  of  railroads  was  inadequate. 

2For  a  complete  discussion  of  this  subject  see  previous  chapter. 


312  INVESTMENT  ANALYSIS 

vestment  position  of  the  securities.  As  long  as  property  invest- 
ment is  represented  back  of  capitalization,  it  makes  no  differ- 
ence to  the  investor  whether  the  capitalization  is  large  with 
high  earnings  or  the  capitalization  low  with  small  earnings, 
when  the  relative  margins  above  the  fixed  charges  are  equiva- 
lent. For  of  what  value  is  a  low  capitalization  if  income  fur- 
nishes inadequate  margins  to  fixed  charges? 

It  is  apparent  from  this  latter  that  the  proportion  between 
borrowed  and  proprietary  capital  would  be  a  determinant  in 
the  safety  of  the  bonds.  Even  if  the  capitalization  were  high, 
and  the  proportion  of  bonds  low,  the  bonds  could  occupy  a 
strong  position.  On  the  other  hand,  if  a  very  large  over-capi- 
talization were  represented  in  the  capital  stock  issues,  the  gen- 
eral credit  of  the  company  would  be  affected  and  the  value  of 
these  stocks  would  always  be  subject  to  a  possible  discount  in 
the  valuation  by  some  Public  Service  Commissions.  The  market 
position  of  railroad  stock  under  these  conditions  will  force  the 
railroad  to  market  its  new  stock  at  a  large  sacrifice,  and  this  in 
turn,  will  force  the  issuance  of  bonds.  This  will  destroy  the 
enviable  rank  of  the  bonds,  and  the  corporation  is  penalized  for 
the  over-issue  of  its  capitalization  through  capital  stock.  The 
result  is  a  further  weakening  of  the  railroad  unless  the  added 
improvements  give  a  larger  relative  earning  power.  Koads, 
however,  which  have  a  healthy  capitalization  and  a  large  ratio 
of  stocks  to  bonds  and  which  have  persisted  in  adhering  to  this 
principal  in  new  issues,  have  a  much  better  credit  position  than 
the  company  with  a  large  ratio  of  bonds.  This,  of  course, 
assumes  that  the  railroad  has  low  rental  charges. 


CHAPTEE  XVII 
RAILROAD  EQUIPMENT  SECURITIES 

The  Origin.  —  Equipment  obligations  grew  out  of  the  neces- 
sity of  weak  railroads  to  secure  funds  by  other  methods  than 
those  ordinarily  used  in  floating  fixed  obligations.  Under  the 
handicap  of  a  large  debt,  embarrassed  railroads  could  not  secure 
funds  for  the  purchase  of  equipment  through  the  use  of  the 
general  mortgage.  No  investor  was  willing  to  purchase  a  weak 
railroad's  bonds  or  notes,  whose  tangible  security  depreciated  in 
fifteen  years  or  less  and  was  junior  to  all  existing  funded  debt 
outstanding  at  the  time  of  issue.  This  condition  necessitated 
the  creation  of  an  equipment  obligation  which  could  be  sep- 
arated from  the  other  funded  indebtedness  of  the  railroad.  Out 
of  this  necessity,  a  new  form  of  security  originated  in  the  late 
sixties.1 

While  this  plan  of  financing  in  the  beginning  was  used  only 
by  encumbered  railroads,2  it  was  not  long  before  it  was  recog- 
nized as  a  sound  method  of  financing  for  all  railroads  in  pro- 
viding their  equipment  requirements.  With  the  separation  of 
the  equipment  obligations  from  the  other  funded  debts,  rail- 
roads are  not  required  to  place  an  extraordinary  burden  upon 
current  earnings  of  any  one  year.  Not  only  is  the  burden  of 
the  fixed  investment  reduced,  but  the  distribution  of  the  ma- 
turities reduces  the  interest  charges  and  enables  the  railroad  to 
retire  the  obligations  out  of  current  earnings  before  the  rolling 
stock  is  extinct.  The  growth  in  the  amount  of  equipment 
securities  as  compared  with  the  growth  in  mileage  and  tonnage 


American  Bar  Association  records  a  form  of  equipment  obliga- 
tions as  early  as  1845  of  the  Schuykill  Navigation  Company.  (F.  Rawle, 
Acts  Relating  to  Car  Trusts  in  Force  in  Various  States  (1893),  and 
Amer.  Bar  Assn.  Rep.  322  [1855].  See  also  Commercial  and  Financial 
Chronicle,  vol.  Ixii  [1896],  p.  259). 

"W.  Z.  Ripley,  Railroads  Finance  and  Organization  (1915),  p.  171. 

313 


314  INVESTMENT  ANALYSIS 

is  significant  of  the  importance  that  railroads  have  attached  to 
this  method  of  financing.1 

The  plan  used  in  the  issue  of  equipment  securities  bids  fair 
to  play  an  even  more  important  role  than  hitherto  in  secu- 
rity issues.  The  use  of  these  securities  is  now  being  extended  to 
the  financing  of  machinery  and  equipment  of  industrial  organi- 
zations though  other  public  utilities  have  used  these  securities 
in  a  small  way  for  some  time.  But  certain  uses  are  being  made 
of  these  securities  for  industrial  issues  which  are  unwarranted 
and  if  continued  will  destroy  their  enviable  position. 

While  the  high  character  of  the  railroad  equipment  securi- 
ties has  been  fully  appreciated,  there  are  possible  dangers  in 
the  competition  which  may  arise  between  underwriters  who  are 
willing  to  take  more  questionable  risks.  While  the  rate  of 
return  and  methods  of  payment  will  no  doubt  remain  the  same, 
the  duration  will  probably  be  extended  and  the  amount  of  the 
equities  securing  these  obligations  will  be  lessened.  This  ten- 
dency has  already  appeared  in  some  types.  Conservative  bankers 
fully  appreciate  this  condition  and  are  correspondingly  more 
careful  in  their  own  selections.1 

Classification. — There  are  strictly  speaking  only  two  types 
of  equipment  issues  which  are  based  upon  fundamental  differ- 
ences. The  first  and  oldest  of  these  issues,  the  car  trust  certifi- 
cate, was  created,  as  already  stated,  to  overcome  the  legal 
obstacles  in  priority  of  liens.  The  second  fundamental  type  of 


Per  cent  in- 

1  Amount  of  Per  cent  crease  over  Per  cent 

Equipment         increase  over     Miles  of     previous     increase 
Securities        previous  year     Railroads      year       capital- 
ization 

1S90  $49,000,000  167,191 

1900  60,000,000  22.4  198,964  18  33 

1905  200,000,000  233  225,196          13  20 

1910  350,000,000  70.0  249,992  11  34 

1915  400,000,000  14  270,000  8  6 

(The  period  from  1915-1920  would  not  be  typical  and  is  not  included 
in  the  table.) 

'Because  of  this  possible  later  development  and  the  great  complexity 
of  these  issues,  more  space  is  given  to  the  discussion  of  these  securities 
relative  to  railroad  bonds  in  general  than  probably  would  seem  to  be 
warranted.  The  conditions  referred  to,  however,  seem  to  justify  this 
extended  treatment. 


EQUIPMENT  SECURITIES  315 

these  issues  is  the  equipment  bond  which  is  based  upon  a  con- 
ditional sale.  The  car  trust  bond  while  frequently  used  is  not 
clearly  a  distinctive  type,  though  it  does  vary  in  the  detail  of 
issue  as  explained  later. 

The  plan  under  which  the  car  trust  certificates,  commonly 
known  as  the  Philadelphia  plan,  are  issued,  has  become  quite 
well  standardized.  The  railroad  enters  into  a  contract  for 
equipment  with  a  manufacturer  and  makes  an  initial  payment 
on  the  stipulated  equipment  without  receiving  other  evidence 
than  a  receipt  for  such  payment ;  that  is,  no  title1  has  been 
acquired  to  the  equipment  by  the  railroad.  When  the  equip- 
ment is  ready  for  delivery,  a  formal  agreement  is  drawn  between 
the  manufacturer  and  an  individual,  an  association,  cor- 
poration, or  a  trust  company.2  Then  one  of  the  latter  leases 
the  equipment  to  a  railroad.3  The  lease  is  then  assigned  by  the, 
individual,  association,  corporation,  or  trust  company,  to  a 
trustee,  and  interest  bearing  certificates  of  "beneficial  interest 
in  the  association"  are  issued  and  sold  to  the  public,  and  the 
proceeds  are  used  to  pay  the  manufacturer.4  The  title  to  the 
equipment  remains  with  the  trustee  for  the  benefit  of  the  share- 
holders until  all  obligations  of  the  issue  have  been  paid.5 

1While  there  are  few  cases  affecting  these  issues  the  courts  seem  to 
have  fully  approved  the  fundamental  principle  underlying  the  car  trust 
certificates.  (See  F.  Rawle,  Acts  Relating  to  Car  Trusts  in  Force  in 
Various  States  [1893].) 

2The  nomenclature  for  these  securities  lacks  proper  standardization, 
and  some  features  are  included  in  certain  types  of  issues  which  were  not 
formerly  used.  More  often  attempts  are  made  to  insert  new  conditions 
or  modify  the  two  existing  standard  forms  of  the  car  trust  certificate 
and  equipment  bond. 

•It  is  not  uncommon  for  the  purchaser  of  the  equipment  to  form  the 
association  which  purchases  the  equipment  or  at  least  to  be  represented 
on  the  association  formed  by  the  manufacturer,  the  railway  company,  or 
even  the  underwriting  bank.  The  American  Investment  Bankers  Asso- 
ciation has  declared  itself  against  this  practice. 

4An  excellent  statement  of  the  procedure  of  the  issuance  of  car  trust 
certificates  is  given  in  the  Commercial  and  Financial  Chronicle,  vol. 
Ixxxii  (1906),  pp.  361-363  and  839-841.  See  also  A.  S.  Dewing,  Railroad 
Equipment  Obligations,  Amer.  Econ.  Rev.,  vol.  iii  (June,  1917),  p.  353. 

The  Investment  Bankers'  Committee  on  Equipment  Securities  in  its 
report  to  the  General  Association  in  commenting  on  ownerships  states : 

"In  addition,  various  schemes  have  been  prepared  by  which  indi- 
viduals or  car  companies  acquired  cars  from  time  to  time  for  the  uses  of 
a  particular  railroad,  arranging  for  leases  of  the  same  to  the  railroad 
and  thereafter  selling  equipment  leased  certificates  to  bankers.  Although 
this  practice  has  become  quite  common,  these  arrangements  are  open  to 


316  INVESTMENT  ANALYSIS 

The  exemption  from  taxation  in  certain  quarters  also  has 
had  an  important  bearing  on  the  issue  of  these  securities.  In 
Pennsylvania,  for  example,  they  are  exempted  on  the  ground 
that  they  represent  a  partial  ownership  on  the  part  of  their 
holders.  There  is  now,  however,  doubt  on  the  part  of  the  best 
legal  opinion,  as  to  whether  the  question  of  taxation  on  these 
securities  has  been  fully  adjudicated.  Particular  care  must  be 
taken  in  every  instance  that  the  issues  represent  physical  prop- 
erty and  the  payments  in  the  underlying  instrument  are  made 
payable  in  "rentals"  and  not  "interest."  As  the  trustee  is 
always  relieved  of  any  obligation  by  the  indenture,  the  pay- 
ment of  these  costs,  if  they  arise,  always  devolves  upon  the  rail- 
road. Even  if  this  obligation  is  not  assumed  in  the  agreement, 
the  practice  has  been  for  railroads  to  pay  all  such  obligations, 
regardless  of  the  shareholder's  residence.  Because  of  this 
practice  any  references  to  the  assumption  of  such  obligation 
have  generally  been  omitted  in  the  trust  deeds  of  Pennsylvania 
organizations. 

These  certificates1  are  usually  further  guaranteed  as  to  prin- 


question  on  the  ground  that  these  individuals  are  usually  either  the  rail- 
road itself  in  a  different  form,  the  stock  of  the  car  company  usually  being 
owned  by  the  railroad  company  and  the  individuals  being  agents  of  the 
railroad  company  and  not  representing  anybody  else. 

"We  do  not  refer  here  to  the  so-called  form  of  equipment  trust  issued 
under  what  is  commonly  known  among  bankers  as  the  Philadelphia  plan, 
but  to  certain  other  forms  of  trusts  in  which  individuals  appear  as 
lessors." 

(Proceedings  of  the  Third  Annual  Convention  of  the  American  In- 
vestment Bankers'  Association  [Phil.,  Nov.,  1914],  pp.  40-41). 

formerly  additional  warrants  were  issued  in  conjunction  with  the 
lease,  but  they  are  now  considered  unessential,  and  have  been  super- 
ceded  by  the  endorsement  of  the  car  trust  certificates  by  the  railroad. 
And  it  may  be  said  that  most  of  the  legal  changes  which  have  been  en- 
acted to  protect  the  trust-certificate-holders  have  had  little  effect  on  the 
original  purpose  of  this  security.  Also,  no  statutory  recognition  was 
formerly  made  of  conditional  sales  of  personal  property.  All  personal 
property  had  to  be  recorded  either  in  the  township  or  county  where  found. 
For,  if  the  equipment  were  found  in  a  locality  in  which  it  had  not  been 
recorded,  any  creditor  in  that  locality  would  have  had  prior  claim  to  the 
equipment  claimants.  And  any  separation  of  a  railroad's  funded  debt 
from  its  equipment  obligations  that  left  the  title  to  the  equipment's  own- 
ership with  the  railroad  was  also  impractical.  Equipment  security- 
holders  under  such  an  arrangement  were  still  subject  to  all  prior  claims. 
These  difficulties  have  now  been  largely  overcome  by  modifications  of  the 
law  which  dispense  with  the  innumerable  registrations  that  formerly 
made  the  conditional  sale  impracticable. 


EQUIPMENT  SECURITIES  317 

cipal  and  interest  by  the  railroad  company.  But  this  guaran- 
tee has  never  resulted  in  any  financial  benefit  to  the  owners 
of  equipment  certificates.  As  long  as  the  holders  of  these  securi- 
ties have  prior  claim  to  the  rolling-stock,  the  real  test  of  any 
guarantee  is  receivership. 

The  question  as  to  whether  car  trust  bonds  can  be  classed  as 
a  distinct  type  of  issue  has  already  been  raised.  Their  use. 
however,  seems  to  warrant  a  statement  concerning  their  char- 
acteristics. The  car  trust  bond  differs  from  the  car  trust  cer- 
tificate in  that  the  car  trust  bond  is  a  mortgage  on  the  lease — 
i.  e.,  a  direct  obligation — whereas  the  car  trust  certificate  repre- 
sents only  a  "beneficial  interest  in"  the  lease  assigned  to  the 
trustee.  Though  technically  this  distinction  must  be  made  be- 
tween the  car  trust  certificate  and  the  car  trust  bond,  in  prac- 
tice it  is  seldom  made.  Neither  is  the  distinction  very  vital 
financially,  as  the  security  of  both  classes  of  obligations  rests 
ultimately  upon  the  ownership  and  lease  of  the  rolling-stock. 

The  equipment  bond  or  equipment  note,1  the  most  modern 
of  these  issues,  is  a  direct  obligation  of  the  railroad.  After  the 
specifications  of  the  equipment  and  the  terms  of  sale  have  been 
agreed  upon,  the  railroad  company  makes  an  advance  payment, 
usually  from  ten  to  twenty-five  (more  frequently  ten)  per  cent 
of  the  cost  of  the  equipment.  Under  this  agreement,  a  condi- 
tional sale  is  then  made  to  the  railroad,  and  bonds  or  notes  are 
issued  under  authority  of  the  trustee  to  complete  the  payment 
for  the  equipment.  These  bonds  or  notes  are  a  direct  obliga- 
tion of  the  railroad  and  a  first  mortgage  on  all  equipment  pur- 
chased under  this  agreement.  But  the  title  for  the  benefit  of 
the  security-holders  is  vested  in  the  trustee  until  all  the  bonds 
or  notes  and  all  of  their  attendant  expenses  under  this  agree- 
ment have  been  paid.  The  payments  of  these  securities,  as  in 
the  car  trust  certificates,  are  usually  made  in  serial  form.  If 
the  payment  is  in  the  form  of  a  sinking  fund,  which  is  rare, 
the  adjustment  is  similar  to  the  settlement  of  any  mortgage 
bond. 


'The  plan  under  which  these  issues  are  made  is  commonly  known  as 
the  New  York  plan.  Why  it  is  called  the  New  York  plan  no  one  has  been 
able  to  explain. 


318  INVESTMENT  ANALYSIS 

Trust  Deed. — As  stated  in  the  description  above,  these 
securities  involve  three  parties.  In  the  issue  of  the  equipment 
bond  the  manufacturer  makes  a  conditional  sale  to  the  railroad, 
which  issues  a  direct  mortgage  on  the  rolling-stock  purchased 
and  then  assigns  the  chattel,  securing  the  bonds  to  a  trustee 
for  the  protection  of  the  bondholders.  In  the  issuing  of  the 
car  trust  certificates  and  the  car  trust  bonds,  an  association  is 
formed.  The  security  of  the  latter  is  a  mortgage  on  the  lease 
of  the  rolling-stock  that  is  assigned  to  a  trustee,  while  the  car 
trust  certificate  is  a  certificate  of  participation  in  the  associa- 
tion. In  both  forms  of  issue,  the  leasing  organization  must  be 
distinct  from  the  railroad  company.  The  procedure  is  also  the 
same  if  a  corporation,  individual,  etc.,  acts  instead  of  the  asso- 
ciation. 

The  first  and  most  important  problem  of  the  trust  deed  in 
equipments  is  to  determine  whether  the  title  to  the  equipment 
is  properly  vested  in  the  trustee.  The  Investment  Bankers' 
Association  has  so  completely  covered  the  underlying  require- 
ments of  the  proper  vesting  of  title  in  the  trustee  that  the  form 
of  indenture  suggested  by  a  committee  of  this  Association  is 
given  in  full  in  Appendix  B. 

While  the  technical  form  of  the  indenture  is  somewhat  dif- 
ferent in  each  case,  the  fundamental  requirements  affecting  the 
rolling-stock  are  much  the  same.  A  cash  payment  of  10  per 
cent  or  more  of  the  value  of  the  equipment  is  required,  and 
securities  are  then  issued  against  the  balance,  and  secured  as 
before  stated.  A  name  plate  indicating  the  trustees  relation- 
ship to  the  title  in  the  property  must  then  be  placed  on  each 
piece  of  equipment,  and  no  other  claimant's  name  can  appear 
during  the  life  time  of  the  security  except  the  name  of  the  rail- 
road company.  The  latter  is  also  obligated  to  report  annually  or 
semi-annually  as  to  the  number,  size,  service  of  equipment,  the 
amount  destroyed,  and  the  number  substituted  and  undergoing 
repair,  which  are  subject  to  the  indenture.  The  railroad,  also, 
must  keep  all  rolling-stock  insured  and  in  repair,  pay  for 
all  taxes,  provide  for  the  regulation  of  all  patents  and  safety 
devices,  and  for  all  outlays  or  reasonable  expenses  made  by  the 
trustee.  The  trustee  is  not  liable  except  for  neglect,  and  is 
usually  required,  on  default  of  any  payments  due,  to  seize  the 


EQUIPMENT  SECURITIES  319 

equipment  after  a  stated  period,  usually  thirty  days.  The  writ- 
ten consent  of  a  certain  percentage,  ordinarily  50  per  cent,  of  the 
security  holders  must  be  had  to  give  the  trustee  the  authority 
to  take  action.  Anything  less  than  50  per  cent  is  question- 
able. A  large  institutional  holder  of  an  equipment  issue 
recently  refused  to  accede  to  certain  requests  until  reminded 
that  25  per  cent  of  the  holders  could  authorize  an  action.  Nor- 
mally, it  is  not  the  part  of  wisdom  to  allow  such  a  small  ratio 
to  determine  action  on  this  kind  of  a  security. 

If  the  railroad  has  purchased  equipment  on  conditional  sale, 
all  the  provisions  found  in  the  lease  of  the  car  trust  certificate 
and  trust  deed  are  found  in  the  trust  deed  of  the  equipment 
bond,  as  the  lease  in  the  strict  sense  does  not  exist  in  a  condi- 
tional sale.  In  the  latter,  direct  semi-annual  or  annual  inter- 
ests payment,  and  in  the  former,  the  rentals  are  so  apportioned 
that,  when  the  last  payment  falls  due  the  whole  obligation  has 
been  cancelled.  The  essential  safeguards  in  well-drawn  instru- 
ments of  either  class  are  practically  the  same,  varying  only  in 
the  technicalities  peculiar  to  the  respective  instruments. 

Duration  and  Terms  of  Payment. — The  standard  period  of 
equipment  securities  has  been  ten  years.  The  Pennsylvania 
Equipments,  which  fell  due  on  September  1st,  1914,  with  a 
tenure  of  twenty-five  years,  and  the  Bessemer  and  Lake  Erie 
issues  of  twenty  years  are  the  exception  and  not  the  rule. 
Since  1907  the  Chicago,  Rock  Island  and  Pacific  Railway,  the 
New  York  Central  Lines,  the  Lehigh  &  New  England  Railroad, 
and  a  few  other  systems  have  issued  fifteen-year  series. 
Whether  the  fifteen-year  maturities  will  be  substituted  for  the 
ten-year  maturities,  it  is  yet  too  early  to  determine.  The  wide 
margin  of  safety  that  these  securities  have  possessed  under  the 
ten-year  period  has  been  the  large  factor  in  contributing  to 
the  high  character  of  these  securities.  But  to  condemn  an 
increased  duration  upon  this  basis  is  hardly  justified. 

Serial  payments  have,  with  a  very  few  exceptions,  been  such 
a  fixed  part  of  the  method  of  issuing  equipment  securities  that 
it  has  never  seemed  necessary  to  give  this  question  any  consid- 
eration. The  adoption  of  the  serial  method  of  payment  in  the 
early  issues  was  not  a  matter  of  choice  on  the  part  of  the  weak 


320  INVESTMENT  ANALYSIS 

railroads,  but  a  requirement  arbitrarily  demanded  by  the  lend- 
ers, because  of  the  short-lived  equity.  "Whether  this  method  of 
repayment  will  be  continued  with  the  change  in  the  character 
of  equipment  and  the  shifting  to  other  methods  in  financing 
other  fixed  property,  is  open  to  question.  With  an  asset  which 
depreciates  so  rapidly,  the  safest  and  cheapest  method  is  to 
increase  the  equity  behind  the  securities  at  an  increasing  ratio 
to  the  longer  maturities ;  otherwise,  the  cost  of  financing  will  be 
too  great. 

When  the  investment  of  the  sinking  fund  is  limited  to  cer- 
tain uses  or  investments,  the  company's  credit  is  strengthened, 
but  it  does  not  necessarily  affect  to  a  corresponding  degree  the 
strength  of  equipment  issues.  Further,  if  the  sinking  fund  is 
held  in  the  form  of  a  savings  bank  deposit,  it  will  yield  only  3 
per  cent,  and  companies  are  not  willing  to  sacrifice  the  higher 
rate  obtainable  in  the  other  forms  of  investments.  The  experi- 
ences of  the  past  have  shown  that  where  the  sinking  fund 
existed  in  the  form  of  cash  deposits,  the  temptation  to  use  this 
cash  for  other  than  its  original  purpose  has  always  been  great- 
est with  the  systems  in  a  questionable  financial  position.  And 
these  systems  have  always  misused  their  sinking  funds  when 
these  reserves  should  have  been  most  carefully  protected.  The 
method  of  administration  and  character  of  investments  must 
always  be  the  real  tests  of  a  sinking  fund.  The  sinking  fund 
experience  of  early  American  railroads  will  never  be  repeated  in 
the  same  promiscuous  fashion,  though  it  is  unreasonable  to 
expect  a  railroad  having  a  reserve  not  to  use  these  funds,  when 
it  finds  itself  in  a  strained  position.  It  is  obvious  that  the 
restrictions  safeguarding  such  a  reserve  are  the  real  test  of  the 
worth  of  a  security.  There  have  been  times  in  the  history  of 
the  majority  of  American  railroads  when  it  was  essential  to 
borrow  in  order  to  maintain  a  sinking  fund.  Sounder  financing 
would  have  demanded  the  temporary  suspension  of  the  sinking 
fund,  for  the  necessity  of  borrowing  in  order  to  maintain  a 
sinking  fund  ultimately  increases  the  total  amount  of  the  debt. 

Physical  Factors  of  Equipment. — The  rapid  obsolescence  and 
deterioration  of  equipment  have  made  it  difficult  to  establish  an 
absolute  and  common  standard  of  measurement  that  could  be 


EQUIPMENT  SECURITIES  321 

applied  to  all  railroads.  The  relative  improvements  in  rolling- 
stock  have  been  much  greater  than  in  road  beds,  terminal  build- 
ings, etc.  Locomotives  which  ten  years  ago  were  built  for  fast 
passenger  or  heavy  freight  traffic  are  now  used  only  on  branch 
lines.  Obsolescence,  as  pointed  out  under  "Depreciation,"  may 
become  the  most  important  factor  in  a  consideration  of  the  value 
of  the  equipment  underwritten.  This  suggests  the  necessity  of 
a  careful  examination,  not  only  of  the  model  and  capacity  of 
all  equipment,  but  also  of  the  respective  distribution  of  coal- 
cars,  passenger-cars,  locomotives,  etc.,  securing  an  indenture. 

If,  for  example,  the  safest  security  of  the  principal  is  de- 
manded, locomotives  should  not  constitute  a  very  large  percent- 
age of  the  security.  Not  only  have  the  improvements  been  much 
greater  on  locomotives  than  on  other  rolling-stock,  but  the 
effect  on  operating  costs  and  earnings  has  been  relatively  much 
greater.  The  present  articulated  Mallett  compound  engine,  for 
example,  is  capable  of  drawing  twrice  the  load  of  the  old  single 
expansion  locomotive.  With  the  increased  tractive  power,  the 
mere  numerical  strength  of  a  railroad  in  locomotives  may  be 
entirely  misleading.  An  actual  decrease  in  the  number  of 
locomotives  has  taken  place  relative  to  the  growth  of  tonnage 
on  the  heavy  freight  roads. 

The  efficiency  of  a  railroad  is  dependent,  not  only  upon  the 
capacity  and  tractive  power  of  its  locomotives,  but  upon  their 
adaptability  to  the  needs  of  its  traffic.  A  system  which  is 
largely  a  coal  carrying  road  or  has  heavy  grades  or  great 
density  could  of  necessity  demand  a  large  number  of  locomo- 
tives of  high  tractive  power.  But  great  tractive  power  in  loco- 
motives means  lessened  speed,  and  makes  them  less  efficient  for 
passenger  and  fast  freight  services,  which  demand  low  tractive 
power  and  high  speed.  Even  with  the  great  trunk-lines  of  the 
United  States,  which  demand  a  wide  variety  of  equipment,  each 
system  will  usually  demand  that  a  majority  of  its  rolling-stock 
be  of  one  type.  Any  other  policy  than  that  of  the  adaptation 
of  equipment  to  traffic  needs  must  affect  the  operating  efficiency. 
And  any  valuation  of  locomotives  which  takes  no  recognition  of 
this  fact  must  always  be  in  error. 

Mere  numerical  comparison  of  cars,  even  of  the  same  kind, 


322  INVESTMENT  ANALYSIS 

may  have  little  significance.  They  will  differ  not  only  in  capac- 
ity, but  in  original  cost,  in  repair  expenses,  in  their  length  of 
life,  and  in  the  uses  of  the  equipment.  The  problem  of  effici- 
ency in  car  service  is  much  the  same  as  that  of  locomotive — 
one  of  adaptation  to  the  needs  of  the  system.  To  have  too  large 
cars  is  just  as  costly  as  to  operate  too  small  cars.  It  is  also 
uneconomical  for  a  railroad  that  has  heavy  or  dense  traffic  to 
possess  many  cars  that  cannot  be  loaded  to  the  fullest  capacity, 
and  vice  versa,  for  light-weight  traffic. 

A  few  facts  concerning  changes  in  car  equipment  verify 
these  contentions.  The  average  capacity  of  the  ordinary  box- 
car in  1920  is  about  three  and  one-half  times  what  it  was  in 
1870.  The  wooden  box-car  of  a  decade  ago  is  now  being  rapidly 
displaced  by  the  under-frame  steel  or  all  steel  car,  and  from 
85  to  90  per  cent  of  the  freight  cars  now  built  are  of  either  the 
last  two  classes.  The  new  steel  passenger  day-coach  has  in- 
creased its  carrying  capacity  over  the  old  wooden  coach  approx- 
imately 100  per  cent.  With  the  increased  use  of  heavier  mate- 
rial, the  dead  weight  has  also  materially  increased.  In  a  steel 
de  luxe  passenger  train,  the  weight  of  the  passengers  is  ex- 
tremely small  as  compared  to  the  total  weight  of  the  car.  The 
steel  under-frame  box-car  has  increased  on  the  average  about 
100  per  cent  in  carrying  capacity  and  50  per  cent  in  dead 
weight  over  the  old  wooden  car. 

Depreciation.* — Any  statement  bearing  upon  depreciation 
can  be  only  an  approximation.  But,  an  approximation  of  de- 
preciation is  adequate,  if  a  sufficient  margin  is  allowed  between 
the  last  payment  of  the  principal  and  the  final  extinction  of  the 
obligation.  By  the  semi-annual  or  annual  cancellation  of  a 
proportionate  amount  of  the  principal  above  the  margin 
allowed,  original  equity  is  thus  more  than  maintained  during 
the  life  of  the  outstanding  securities.* 

With  normal  usage  and  proper  upkeep  of  the  equipment, 
the  equity  of  these  bonds,  theoretically  at  least,  increases  with 

*See  the  Master  Car  Builders'  Association  Manual  for  details  of  de- 
preciation allowances. 

2See  various  briefs  of  the  Interstate  Commerce  Commission  on  Val- 
uations. 


EQUIPMENT  SECURITIES  323 

each  payment  of  the  principal.  While  the  actual  depreciation 
of  the  equipment  will  be  less  in  the  first  year  of  its  service,  the 
sale  price  must  be  more  than  correspondingly  discounted, 
as  rolling-stock  which  is  once  put  into  service  can  be  marketed 
only  as  second-hand  goods.  But  the  sale  price  of  equipment, 
compared  with  its  operating  value,  toward  the  end  of  the  life 
of  the  equipment  would  relatively  be  discounted  at  less  than  dur- 
ing the  second  year's  use  of  the  equipment.  On  the  average,  if 
the  terms  of  the  indenture  have  adequately  provided  for  the 
protection  of  the  equipment,  and  the  trustee  has  enforced  these 
requirements,  a  sufficient  sale  price  could  undoubtedly  be 
secured,  if  the  railroad  went  into  insolvency,  to  pay  the  remain- 
ing bonds  in  full.  If  the  old  term  of  ten-year  bonds  is  con- 
tinued, with  the  increased  use  of  steel  in  equipment,  the  equity 
will  become  correspondingly  greater  toward  maturity.  This 
advantage  may  be  offset  by  an  increase  in  the  term  of  the  bonds. 

The  number  of  variables  is  too  great  to  establish  any  other 
than  an  approximate  average.  But  for  all  practical  purposes 
the  average  depreciation  is  sufficient  to  determine  the  equity 
against  outstanding  bonds.  Depreciation  will  vary  not  only 
between  different  roads,  but  with  the  same  road  at  different 
seasons  of  the  year.  The  density  and  character  of  traffic,  the 
nature  of  the  roadbed  and  topography  of  the  country,  the  size 
and  the  amount  of  rolling-stock,  the  character  and  age  of  the 
equipment  already  owned,  all  must  be  determined  before  a 
correct  measurement  or  comparison  of  depreciation  or  mainte- 
nance can  be  made.1  The  Interstate  Commerce  Commission  since 
1907  has  required  that  depreciation  be  written  off  annually. 

Maintenance  and  Renewals.  —  The  Interstate  Commerce 
Commission  under  the  1920  Federal  statute*  is  forced  to  main- 
tain specific  rules  governing  the  maintenance  charges  of  the 
rolling-stock.  All  trust  deeds  or  leases  require  that  the  rail- 
road shall  maintain  all  equipment,  but  these  instruments  usually 
do  not  state  the  amount.  If  any  stipulated  allowance  is-  made, 
the  Master  Car  Builders'  Association  rules  are  used  which  put  a 


S.  Dewing,  The  Financial  Policy  of  Corporations   (1920), 
vol.  i.  p.  101  seq.  footnote. 

'Federal  Law  of  February  28,  1920. 


324  INVESTMENT  ANALYSIS 

specified  price  upon  each  part.  The  indenture  or  lease  also 
requires  that  if  any  rolling-stock  is  sold  or  destroyed,  it  must 
be  replaced.  The  latter,  of  course,  is  covered  by  insurance. 
But,  even  when  these  allowances  are  made,  any  single  standard 
cannot  be  used  for  comparative  purposes. 

Experiences  similar  to  those  of  the  Illinois  Central  Railroad 
indicate  the  necessity  of  close  scrutiny  of  maintenance.  While 
fraud,  as  in  the  "farming  out"  of  the  Illinois  system  in  1909- 
10,  is  very  rare,  the  greatest  waste  may  occur  under  this  item. 
Much  the  same  variables  which  affect  depreciation  affect  main- 
tenance cost,  and  in  any  comparative  analysis  of  maintenance 
costs,  the  same  data  and  same  variables  must  be  used.  For 
illustration,  it  is  very  obvious  that  if  a  company  has  a  consid- 
erable amount  of  old  rolling-stock  when  new  equipment  is 
added,  the  maintenance  cost  must  be  disproportionate  to  that  of 
a  road  having  a  large  amount  of  new  equipment. 

The  age  of  equipment  has  a  more  important  bearing  upon  the 
cost  of  maintenance  than  any  other  single  item.  Some  of  the 
large  packing  companies  have  found  it  more  profitable,  after 
a  car  is  ten  or  twelve  years  of  age,  to  dispose  of  it  and  purchase 
new  equipment,  because  of  the  high  maintenance  charges  after 
this  period.  In  one  class  of  refrigerator-cars,  prior  to  1914,  for 
illustration,  the  charges  ran  as  follows:  for  the  first  five  years, 
$40;  for  the  second  five  years,  $110;  for  the  third  five  years, 
$120.a  The  life  of  these  same  cars  was  estimated  at  fifteen  years 
with  a  salvage  recovery  of  10  per  cent  of  the  original  cost. 

The  degree  of  care  with  which  train  crews  operate  on  dif- 
ferent systems  has  been  found  to  materially  cut  or  increase 
these  costs.  This,  of  course,  does  not  account  for  the  variation 
in  wear  and  tear  caused  by  the  differences  in  road  beds,  amount 
of  rolling-stock,  topography,  character  of  traffic,  etc.  If  a  con- 
siderable amount  of  a  railroad's  equipment  is  rented,  the  main- 
tenance charge  will  be  deceptive  as  a  criterion  of  the  road's 
condition,  as  no  part  of  the  rental  is  charged  to  this  account 
but  must  appear  in  the  account  of  the  owner. 


'From  a  confidential  report  based  upon  a  private  investigation  of  a 
large  corporation. 


EQUIPMENT  SECURITIES  325 

Insurance. — All  trust  deeds  require  that  all  equipment  be 
insured.  The  amount  of  this  insurance  is  usually  left  either  to 
the  railroad  or  to  an  agreement  between  the  railroad  and  the 
trustee.  A  few  trust  deeds  stipulate  that  the  amount  shall  be  a 
stated  rate  of  the  valuation  placed  on  equipment  by  the  Master 
Car  Builders'  Association.  A  great  deal  more  emphasis  has  been 
placed  by  the  average  laymen  on  the  importance  in  the  trust 
deed  of  insurance  than  is  really  warranted.  Rolling-stock  is 
always  widely  scattered  and  the  destruction  of  any  large  amount 
of  the  equipment  securing  any  one  issue  is  highly  improbable. 
The  factors  governing  the  amount  of  this  insurance  would  be 
determined  as  follows:  first,  the  percentage  of  the  equipment 
under  the  indenture  to  the  total  equipment  of  its  kind;  second, 
the  average  percentage  of  equipment  destroyed  by  wreckage, 
fire,  etc.  (To  assume  a  greater  insurance  charge  than  this 
would  involve  a  useless  expenditure  for  the  road.)  This  risk 
would  not  average  more  than  10  per  cent  during  the  life  of 
the  equipment,  and  a  20  per  cent  risk  would  give  more  than 
an  ample  margin  for  all  losses. 

Investment  Position. — A  great  deal  of  unwarranted  preju- 
dice has  existed  among  certain  investors  against  equipment 
securities.  This  can  be  largely  attributed  to  the  risk  of  a  secu- 
rity which  is  dependent  upon  a  property  that  deteriorates  as 
quickly  as  rolling-stock.  When,  however,  the  legal  safeguards 
of  equipment  obligations  which  protect  the  shareholder  are  thor- 
oughly understood,  this  opposition  is  soon  changed.  Because 
of  this  misunderstanding  several  state  legislative  requirements 
for  legal  savings  have  excluded  equipment  obligations  as  a  form 
of  legal  investments.  In  consequence,  many  of  the  small  trust 
companies,  savings  banks,  and  trustees  have  also  been  influenced 
to  refrain  from  purchasing  equipment  obligations.  This  situ- 
ation has  been  especially  true  of  car  trust  certificates.  A  small 
New  York  State  banking  house  during  the  summer  of  1914,  fol- 
lowing the  outbreak  of  the  European  War,  requested  a  friend 
at  the  head  of  a  certain  bond  house  to  replace  with  bonds  the 
certificates  of  participation  of  a  large  and  important  issue  which 
it  held  as  a  collateral  on  a  loan.  The  claim  of  the  credit 
department  was  that  under  the  peculiarly  strained  market  "no 


326  INVESTMENT  ANALYSIS 

stock"1  could  be  accepted  as  collateral.  It  is  to  be  feared  that 
this  credit  man,  considering  the  strength  of  this  issue,  was  not 
very  familiar  with  equipment  obligations. 

From  this  standpoint  of  investment  safety  and  rate  of 
return,  no  class  of  securities  has  enjoyed  as  enviable  a  record 
as  equipment  securities.  From  1880  to  1915  no  losses  are  re- 
ported, though  a  great  number  of  railroads  which  had  equip- 
ment securities  outstanding  did  go  into  receivership.2  Equip- 
ment securities  have  necessarily  been  given  precedence  because 
of  a  railroad's  need  of  equipment  to  continue  business.  A 
bankrupt  railroad  would  find  it  not  only  more  costly  to  secure 
funds,  at  frequent  intervals,  for  new  equipment,  but  probably 
impossible.  The  best  expediency  for  the  railroad  has  always 
been  to  fully  safeguard  the  equipment  security  holder. 

In  a  few  cases,  as  the  Norfolk  and  Western  (1896)  and  the 
Denver  and  Rio  Grande  Railroad  (1886),  the  security  holders 
were  not  paid  in  cash,  but  were  given  bonds  in  partial  settle- 
ment. These  securities,  as  in  all  the  other  instances  of  similar 
adjustment,  eventually  rose  in  price,  so  that,  if  the  security 
holder  had  desired  to  dispose  of  his  holdings  at  the  increased 
price,  a  considerable  profit  would  have  been  realized  over  the 
original  principal  of  the  equipment  security  holdings.* 

While  it  is  common  practice  for  the  railroad  to  make  a  guar- 
antee of  the  principal  and  interest,  these  guarantees  do  not  add 
much  to  the  value  of  equipment  securities.  A  guarantee  of  the 
issue  of  a  subsidiary  company,  however,  made  by  a  parent  road, 
may  prove  of  value ;  though,  even  here,  if  the  issue  is  properly 
made  and  secured  the  guarantee  is  of  little  consequence.  In  a 
few  rare  instances,  the  manufacturer  of  the  equipment  will 


''The  stock  certificates  referred  to  here  were  the  car  trust  certificates. 

2The  Guaranty  Trust  Company  in  its  little  book  on  Railway  Equip- 
ment Obligations  gives  a  long  list  of  railroad  reorganizations  in  which 
equipment  obligations  were  not  disturbed. 

In  two  instances  of  receivership  the  holders  were  obliged  to  take 
over  the  equipment  and  resell  it  but  without  loss.  These  railroads  were 
the  Buffalo  and  Susquehanna  Railway  and  the  Detroit,  Toledo  and  Iron- 
ton.  Both  of  these  issues  were  not  carefully  drawn. 

8The  only  compromise  of  an  equipment  issue,  known  to  the  author,  is 
that  of  the  Wheeling  and  Lake  Erie  Equipment  Sinking  Fund  Gold  Bonds. 
The  conditions  under  which  the  issue  was  originally  brought  were  un- 
warranted in  the  light  of  the  condition  of  the  railroad. 


EQUIPMENT  SECURITIES  327 

make  the  guarantee.  A  very  considerable  number  of  issues  are 
also  subject  to  redemption  at  a  slight  premium,  usually,  rang- 
ing from  1  to  3  per  cent. 

The  convertibility  of  these  securities  varies  directly,  as  the 
strength  of  the  railroad,  and  indirectly,  as  the  term  of  matu- 
rity. Equipment  securities  of  three  years  and  less  possess  a  high 
degree  of  convertibility.  The  longer  maturities  possess  about 
the  same  convertibility  as  other  funded  debts  of  equal  dura- 
tion. When  the  price  of  the  short  maturities  equals  that  of 
good  commercial  paper,  there  is  always  a  strong  demand  by 
the  banks  for  these  securities.  When  equipment  obligations  are 
more  widely  understood  by  investors,  the  maturities  acceptable 
to  the  banks  will  be  increased  and  the  degree  of  convertibility 
of  the  already  accepted  maturities  will  also  be  greatly  increased. 
This  will  make  the  equipment  obligations  more  highly  desirable 
both  for  banks,  and  for  the  surplus  of  any  business. 


CHAPTER  XVIII 

STREET  RAILWAYS  AND  INTERURBAN  TRACTION 
COMPANY'S  BONDS 

History — Urban  Companies. — The  early  development  of 
urban  traction  systems  had  little  in  common  with  urban  trans- 
portation systems  of  today ;  consequently,  from  their  history  no 
lessons  of  value  can  be  drawn  that  will  assist  the  student  in 
the  study  of  the  present  street  railway  securities.  In  less  than 
thirty  years,  urban  and  interurban  transportation  have  passed 
from  the  cumbersome  and  slow  moving  horsecar  to  the  elec- 
trically propelled  car  which,  in  the  passenger  express  service  of 
the  interurbans,  compares  favorably  with  the  modern  railroad. 
The  short  life  of  street  railway  equipment  and  the  rapid  suc- 
cession of  electric  improvements  and  inventions  have  made  this 
phenomenal  development  possible.  Even  where  equipment  has 
not  fully  deteriorated,  it  has  often  been  profitable  to  throw  it 
into  the  junk  heap,  because  of  the  superior  efficiency  of  the  new. 
The  growth  of  new  business,  both  through  the  increase  of  popu- 
lation and  the  growing  habit  in  the  use  of  public  utilities,  has 
made  this  possible.  In  the  purely  speculative  and  badly  man- 
aged properties,  results  have  been  less  desirable  and  over-capi- 
talization has  accumulated.  However  this  would  have  probably 
resulted  in  any  properties  so  managed. 

The  first  street  railway  of  commercial  importance  began  with 
the  so-called  "John  Mason  Cars"  on  Fourth  Avenue,  New  York 
City,  which  ran  on  cleats  nailed  to  the  paving  blocks.  The 
cable  cars,  the  next  form  of  local  transportation  in  a  number 
of  cities,  were  first  introduced  in  San  Francisco  in  August, 
1873.  This  system  gave  promise  for  a  time  of  dominating 
where  traffic  was  dense  enough  to  warrant  the  outlay,  but  its 
experience  for  the  country  at  large  did  not  last  beyond  a  quar- 

328 


STREET  RAILWAY  BONDS  329 

ter  of  a  century.1  Electric  transportation,  which  has  since  sup- 
planted all  other  systems  of  street  railway  transportation,  was 
extremely  slow  in  being  recognized.  The  earliest  effective  com- 
mercial laboratory  experiments  in  electric  transportation  began 
about  the  time  of  the  introduction  of  railroads,  but  it  was  not 
until  fifty  years  later  that  the  use  of  electric  cars  could  be  called 
a  success.  With  the  experiments  of  Stephen  D.  Field  and 
Thomas  A.  Edison  in  the  early  eighties,  electrical  transportation 
began  to  assume  the  definite  modern  form  of  locomotion. 
Messrs.  Edward  M.  Bentley  and  Walter  H.  Knight  of  Cleve- 
land, Mr.  John  C.  Henry  of  Kansas  City,  and  Professor  Sydney 
H.  Short  of  Denver,  and  especially  Charles  J.  Van  Depolle,  all 
simultaneously  added  to  the  perfection  of  the  overhead  trolley 
system.  But  the  establishment  of  the  trolley  system  in  Rich- 
mond, Virginia,  by  Frank  J.  Sprague  in  1888,  probably  marks 
more  distinctly  than  any  other  attempt,  the  definite  commercial 
introduction  of  the  modern  electric  system. 

By  1890,  one-sixth  of  the  street  railway  mileage  of  the  total 
10,868  miles  in  the  United  States  was  equipped  in  whole  or 
part  with  electric  motor  power.  In  1917,  this  mileage  had  in- 
creased to  44,676  miles,  with  11,304,660,462  revenue  passengers 
or  more  than  five  times  as  many  revenue  passengers  as  in  1890, 
and  an  increase  in  gross  revenue  from  approximately  ninety 
million  dollars  of  gross  income  to  more  than  seven  hundred  and 
nine  million  dollars  in  1917.2  The  cost  of  construction  and 
equipment  now  exceeds  five  billions,  which,  if  it  yielded  six  per 
cent,  would  give  an  approximate  return  of  $300,000,000  to  the 
investing  public.  Though  these  figures  in  and  of  themselves 
may  seem  to  have  no  direct  bearing  upon  the  subject  of  invest- 
ments, they  show  the  growing  financial  importance  of  this  chan- 
nel of  investments  and  the  increasing  equity  of  these  securities. 


Thomas  Commeford  Martin,  Street  and  Electric  Railways,  U.  8. 
Bureau  of  Census,  Special  Report  on  Street  and  Electric  Railways,  1902, 
p.  159  (1905). 

"This  figure  has,  no  doubt,  been  somewhat  exceeded  at  the  time  of 
this  publication,  but  this  is  the  last  authoritati  e  statement  that  can  be 
made.  All  the  above  data  are  taken  from  the  United  States  Census  Bul- 
letin (1917).  Census  of  Electrical  Industries  (Street  Railways,  Printed 
1920).  These  censuses  are  made  every  five  years,  but  two  or  three  years 
elapse  before  they  are  published  and,  consequently,  they  are  only  of  his- 
torical value. 


330  INVESTMENT  ANALYSIS 

On  the  other  hand,  street  railways  are  relatively  new,  and 
their  probable  vicissitudes  have  not  been  fully  measured,  so  that 
the  same  exact  conclusions  cannot  be  made  for  street  railway 
securities  as  are  possible  with  many  other  public  utilities  dis- 
cussed in  this  volume.  Electric-light  securities,  though  equally 
new  and  possessed  of  many  complications,  can  be  subjected  to 
the  more  exact  analysis  essential  to  an  accurate  guide  to  securi- 
ties. The  problems,  however,  involved  in  street  railway  opera- 
.  tion  and  financing  are  more  complicated  and  must  always  be  so. 
Through  the  efforts  and  guidance  of  such  organizations  as  the 
American  Street  Railway  Association  and  its  Bureaus,  scientific 
information  is  being  collected  which  will  be  invaluable  in  street 
railway  security  analysis. 

Consolidation  With  Other  Public  Utilities. — The  combina- 
tion of  the  electric-light  plant  and  the  power  plant  supply  is  not 
so  essential  in  a  large  city  as  it  is  in  the  smaller  cities,  because 
the  business  is  sufficient  to  warrant  independent  operation.  In 
a  number  of  smaller  cities,  unity  of  the  power  supply  is  almost 
imperative,  if  an  adequate  and  continuous  profit  is  to  be  main- 
tained. This  has  been  offset  in  some  cases  by  the  ability  of  the 
small  companies  to  obtain  cheap  current  supplies  from  large 
hydro-electric  power  companies  in  the  vicinity.  When  either 
of  these  conditions  is  absent  in  a  very  small  city,  investment 
in  street  railway  properties  becomes  questionable,  except  under 
special  or  peculiar  conditions  that  require  adequate  and 
detailed  explanation.  In  the  larger  cities,  the  economies 
brought  about  by  the  united  operation  of  all  electrical  proper- 
ties, when  properly  regulated,  ought  to  result  in  better  service, 
and  cheaper  rates  and  greater  profits.  Where  combination  is 
prevented  by  state  or  local  statutes,  repeal  of  the  statute  would 
undoubtedly  encourage  such  unification  to  public  advantage. 

There  has  been  another  aspect  which  has  frequently  been 
created  in  these  consolidations,  especially  the  earlier  ones,  in  the 
excess  price  paid  for  properties  in  order  to  secure  control. 
Many  of  the  properties  were  taken  over  at  over-estimated  valu- 
ations. The  interpretation  of  these  early  consolidations  and 
mergers  of  street  railways  themselves,  which  are  still  a  menace 
to  some  systems,  is  exceedingly  well  put  by  Mr.  Doolittle  of  the 


STREET  RAILWAY  BONDS  331 

American  Street  Railway  Association — it  might  be  incidentally 
stated  that  over-capitalization  has  had  its  greatest  abuse  in  the 
past  in  urban  and  interurban  traction  company  organizations. 

"The  consolidation  or  merger  involved  in  the  purchase  of 
the  separate  lines  for  cash  or  securities  frequently  in  amounts 
in  excess  of  the  cost  of  obtaining  franchises,  expenses  of  pro- 
motion, and  the  cost  of  physical  property.  The  basis  of  acqui- 
sition was  the  value  of  the  owners  rather  than  costs,  such  value 
being  calculated  upon  the  supposed  advantageous  location  of 
lines  and  probable  future  earnings.  In  many  instances,  the 
process  of  consolidation  was  hampered  by  the  efforts  of  the 
owners  to  capitalize  a  'nuisance  value'  which  they  had  endeav- 
ored to  create.  Not  only  did  the  cost  of  the  consolidated  system 
include  the  duplication  of  investment  in  property,  a  large  part 
of  which  was  obsolete,  and  discounted  future  earnings,  but  the 
consolidated  company  also  had  to  assume  such  contracts,  leases, 
or  other  obligations  as  the  predecessor  companies  had  under- 
taken. It  is  certain  that  if  electric  traction  could  have  been 
developed  when  urban  transportation  systems  were  first  needed, 
and  public  officials  had  recognized  the  advantages  of  a  public 
policy  of  regulated  monopoly  rather  than  competition,  sub- 
stantial investments  made  in  the  actual  process  of  growth  of 
urban  street  railways  would  have  been  avoided. 

"The  novelty  of  electric  traction  in  its  early  life  afforded  a 
false  stimulus  to  the  industry  and  fostered  erroneous  ideas  as 
to  the  future  earning  power  of  such  systems.  Because  of  this, 
frequently  the  obligations  assumed  in  consolidation  were  bur- 
dens under  which  the  systems  could  not  profitably  operate. 
High  cost  of  consolidation  or  reorganization,  over-extension, 
changes  in  business  conditions,  and  depression  were  among  the 
chief  causes  contributing  to  the  weakened  financial  position  in 
which  many  companies  soon  found  themselves.  Relief  was 
sought  from  these  conditions  in  receivership  litigation,  which 
involved  considerable  time  and  expense. 

"With  the  development  of  the  community  and  the  growth 
of  the  traction  system,  there  have  come  many  items  of  capital 
investment  which  are  unproductive  in  their  nature.1  Compari- 

1  "The  evidence  before  the  board  would  seem  to  indicate  that  burdens 
have  been  thrown  upon  this  company  faster  than  the  increase  in  traffic 
justifies.  *  *  *  If  it  be  true  that  the  metropolitan  community  is  load- 
ing upon  this  company  burdens  which  it  cannot  bear,  the  community  is 
not  only  unwise  in  its  own  interest,  but  it  is  committing  an  act  of  rank 
injustice  towards  the  6.000  shareholders  who  have  come  forward  to  sup- 
ply capital  amounting  to  $25,586,828,  including  premiums."  Second  An- 
nual Report  of  the  Public  Service  Commission  of  Massachusetts,  1914, 
vol.  i,  pp.  440,  441. 


332  INVESTMENT  ANALYSIS 

sons  of  the  relation  of  added  dollars  of  invested  capital  per 
dollar  of  added  gross  earnings  of  several  urban  systems  in 
recent  years  disclose  the  magnitude  of  these  unproductive 
capital  expenditures,  many  of  which  have  been  due  to  onerous 
municipal  requirements."1 

Population  Distribution  and  Its  Effect  on  Traffic. — The  first 
factors  to  be  analyzed  in  a  study  of  street  railway  securities, 
consist  of  the  number,  growth,  riding  habits,  and  distribution 
of  population,  together  with  the  character  of  the  city.  The 
importance  of  these  factors  and  the  minute  study  of  their  rela- 
tionship cannot  be  over-emphasized,  because  it  is  upon  these 
factors  that  revenue  is  dependent.  Whether  the  city  is  strictly 
commercial  and  industrial  or  is  located  in  an  agricultural 
region,  determines  both  the  required  movement  of  the  popula- 
tion and  the  necessity  of  the  use  of  traction  facilities.  The 
demand  for  transportation  will  also  often  be  greatly  increased 
by  the  topography,  as  well  as  the  physical  structure  of  the  city. 
On  the  other  hand,  the  topography  of  a  small-sized  city  has  fre- 
quently made  both  the  cost  of  construction  and  operation  so 
high  that  the  margin  of  security  is  too  small  to  warrant  free- 
dom from  accident.  A  few  years  ago  a  bond  house  refused  to 
underwrite  a  bond  issue  for  a  street  railway,  because  it  was 
located  in  a  town  with  precipitous  hills,  and  the  trolley  com- 
pany had  no  automatic  brake  devices  for  preventing  accidents. 
One  serious  accident  would  either  have  made  very  heavy  in- 
roads upon  the  year's  profits,  or  have  placed  the  company  in 
receivership. 

In  the  sale  of  certain  street  railway  securities  considerable 
stress  has  been  placed  on  the  growth  of  the  city.  Future  esti- 
mates given  in  bond  circulars  are  always  based  upon  the  past 
rate  of  growth.  Statistical  evidence  indicates  that  after  a  cer- 
tain point  in  the  development  of  the  average  city  has  been 
reached,2  "the  population  increases  at  a  decreasing  rate  of 


*F.  W.  Doolittle,  Studies  in  the  Cost  of  Urban  Transportation  Service, 
Bureau  of  Far  Research  of  American  Electric  Railway  Association, 
(1916),  pp.  12  and  13. 

*Bion  J.  Arnold,  Report  on  the  Pittsburgh  Transportation  Problem 
(1910),  p.  139.  The  Report  of  the  Chicago  Traction  and  Subway  Com- 
mission of  1916.  R.  W.  Toll  (Area,  October,  1914)  Denver  Traffic  Inves- 
tigations. This  author  maintains  that  cities  with  a  larger  ratio  of  fair- 
weather  will  show  a  smaller  proportion  of  revenue  passengers  than  the 
average  city. 


STREET  RAILWAY  BONDS  333 

increase."  While  these  conditions  will  have  a  more  percepti- 
ble effect  on  the  appreciation  of  stock  values  than  of  bond 
values,  the  tendency  where  securities  have  been  sold  on  the 
assumption  of  a  predicted  increase  in  growth  in  population, 
(which  prediction  is  seldom  realized)  is  for  bond  prices  to  fall. 

With  a  few  exceptions  of  ou.r  largest  cities,  the  city  with  its 
population  largely  centralized  in  a  small  area,  other  things 
being  equal,  will  show  less  earning  power  than  a  city  with  a 
comparatively  well-distributed  population.  If  all  the  outlying 
areas  of  a  city  are  easily  accessible  from  the  business  areas,  a 
street  railway  three  miles  from  the  center  will  tap  nine  times 
as  great  an  area  as  the  system  only  one  mile  from  the  center; 
i.  e.,  the  area  that  can  be  tapped  is  squared  as  the  radius  of  the 
line  is  extended.  Water  front  and  topographical  location 
usually  prevent  this  simple  method  of  distribution  and  both  a 
more  elaborate  system  and  more  rapid  speed  must  be  attained 
to  reach  the  business  section  of.  the  city  which  may  be  located 
on  this  water  front.  But  the  question  to  be  answered  with  each 
individual  system  is:  Is  the  transportation  system  in  question 
as  efficient  in  its  relation  to  the  distribution  of  population  as  is 
that  of  other  cities  operating  under  similar  conditions? 

George  H.  Davis  found  that  with  the  growth  of  cities  trac- 
tion companies  were  forced  to  haul  greater  distances;  and  as 
the  outlying  areas  were  more  sparsely  settled  the  burden  of 
cost  upon  the  company  was  increased  to  more  than  a  propor- 
tionate part  of  the  additional  revenue.1 

It  cannot  be  assumed  that  the  same  ratio  in  increase  of  earn- 
ings to  the  growth  of  population  will  occur  in  the  future  as 
in  the  past.  While  conservatively  managed  companies  under 
wisely  enacted  public  utility  laws  will  have  a  narrower  margin, 
they  will  have  a  more  certain  source  of  profits.  A  number  of 
the  city  railways  have  reached  a  stage  in  their  development 
where  an  increase  of  fixed  investment  in  mileage  or  equipment 
must  be  studied  with  infinite  care.  With  the  increasing  costs 
of  labor  and  material  and  the  requirements  of  public  utility 
commissions  to  operate  on  closer  margins,  it  is  wholly  inade- 


'George  H.  Davis,  Adjustment  of  American  Street  Railway  Rates  to 
the  expansion  of  City  Areas,  in  Mid-year  Conference  of  American  Electric 
Railway  Association,  January,  1911. 


334  INVESTMENT  ANALYSIS 

quate  for  the  head  of  a  traction  company  to  assume  simply  that 
traffic  will  increase  with  population  and  length  of  mileage. 

The  study  made  by  William  Mattersdorf  of  the  effect  of  the 
growth  of  population  of  German  cities  on  street  railway  earn- 
ings is  interesting  in  comparison  with  the  studies  that  have 
been  made  by  Bion  J.  Arnold  of  American  cities.  When  a 
number  of  the  American  cities  have  reached  the  stage  of  slower 
development,  as  the  majority  of  them  must  eventually  do,  a 
modification  at  least  of  Mr.  Mattersdorf 's  theory  must  apply,  as 
it  is  beginning  to  do  in  a  few  American  cities.  Up  to  a  certain 
point,  states  Mr.  Mattersdorf,  in  the  growth  of  a  city  (he  refers 
here  to  German  cities)  the  gross  earnings  will  increase  at  a 
more  rapid  rate  than  the  population,  then  they  will  fluctuate, 
and  a  marked  retarding  tendency  will  be  noted  in  the  earnings ; 
i.  e.,  while  there  is  still  an  increase  in  growth,  the  ratio  of 
increase  in  earnings  will  be  much  lower.  Mr.  Mattersdorf  has 
shown  in  his  compilation  of  street  railways  in  German  cities,1 
that  after  the  "point  of  saturation"  has  been  reached,  there  is 
a  "limiting  value  beyond  which  there  is  no  increase."  "The 
average  curve,"  he  states  in  another  compilation  of  German 
railway  statistics,  "shows  that  in  cities  up  to  500,000,  the  traffic 
increases  as  the  square  of  the  population,  but  above  that,  in 
only  direct  proportion. ' '  As  Mr.  Watkins  has  emphasized,  even 
this  mathematical  increase  cannot  go  on  indefinitely.  A  com- 
plete saturation  point  will  eventually  be  reached.2  This,  of 
course,  applies  only  where  there  has  been  a  steady  progressive 
expansion  and  not  an  abnormal  one.  If  the  expansion  is  a  sud- 
den one  and  there  is  no  corresponding  increase  in  car  mileage, 
he  further  adds,  there  will  be  a  falling  off  in  traffic  density3 
until  normal  conditions  return.  When  this  point  has  been 
reached,  the  upward  trend  of  the  traffic  curve  tends  toward  a 
horizontal  line  and  other  means  for  carrying  population  must 
be  provided  by  subways  and  elevated  railways  as  in  Boston, 

*Dr.  Ing.  Wilhelm  Mattersdorf  (Zeitschrift  fur  Klinbahnen)  Staat- 
ische  Verkehsfragen  (Berlin,  1907). 

aSee  Watkin's  criticism  of  Matterdorf's  theory  in  New  York  Public 
Service  Commission  Report,  First  District,  1010,  vol.  iii,  p.  30. 

*Car  mileage  and  traffic  density  are  calculated  by  the  same  method 
a?  f '  IT  railroads.  Chap.  xiv. 


STREET  RAILWAY  BONDS  335 

New  York,  and  Philadelphia.  "Where  local  conditions  cause 
variations,  it  is  necessary,  of  course,  to  determine  the  character 
and  permanency  of  these  influences  that  cause  the  deviation 
from  the  general  trend. 

Mr.  Bion  J.  Arnold  states  in  his  analysis  of  the  increase  of 
Pittsburgh  transportation  that :  ' '  a  study  of  the  relative  growth 
of  population  and  of  transit  earnings  of  the  large  American 
cities  during  the  past  ten  years,  shows  some  surprising  results 
and  points  to  the  conclusion  that  as  a  rule,  the  earnings  from 
local  transportation  increase  as  the  square  of  the  population." 
If  this  statement  be  correct,  it  means  that  when  the  population 
of  the  average  community  doubles,  the  earnings  from  trans- 
portation may  be  expected  to  increase  fourfold,  provided  that 
the  transit  facilities  keep  pace  with  the  demand.1  Mr.  Ashe, 
in  a  somewhat  different  comparison,  comes  to  the  conclusion 
that  cities  of  15,000  will  furnish  seventy  passengers  per  annum 
per  inhabitant  up  to  a  constant  increase  of  two  hundred  and 
forty  in  cities  of  1,000,000.2  Bion  J.  Arnold  showed  in  his 
Chicago  report  from  1891  to  1901  an  increase  of  one  hundred 
and  fifty  to  one  hundred  and  eighty-two.8 

Though  some  variations  must  necessarily  exist  as  to  the 
detail  of  the  final  conclusions  in  the  growth  of  population  and 
of  earnings,  it  is  very  evident  that  all  are  agreed  upon  the  check 
of  rate  of  growth  in  population  and  the  retardation  in  earn- 
ings.4 The  rule  cannot  be  accepted  as  rigidly  adaptable  in 
every  city,  but  the  tendency  exists  and  the  variation  and 
causes  of  variation  from  the  average  tendency  must  be  ascer- 
tained for  the  selected  case. 

Density  of  Traffic. — The  density  of  traffic,  when  correctly 
analyzed,  gives  the  best  insight  to  the  profitableness  or  un- 


J.  Arnold,  Report  on  Pittsburgh  Transportation  Problem  to 
Mayor  William  Mag  gee  (1910),  p.  141. 

2W.  Ashe,  Electric  Railways,  vol.  ii. 

3Bion  J.  Arnold.  Report  on  Engineering  and  Operating  Features  of 
the  Chicago  Transportation  Problem  (1902). 

4The  Report  of  the  Transit  Commissioner  (A.  Merritt  Taylor),  vol.  i 
(July  24,  1913),  §10.  shows  a  range  of  71.4  people  per  acre  in  the  first 
mile  zone  from  the  city  hall.  27.0  in  the  fourth  mile  zone,  dropping  to  9.8 
in  the  fifth  and  steadily  decreasing  to  0.5  in  the  16th.  Other  comparisons 
of  New  York,  Brooklyn,  Boston  and  Chicago  are  instructive. 


336  INVESTMENT  ANALYSIS 

profitableness  of  street  railways.  Density  can  be  considered 
from  two  aspects,  the  number  of  passengers  to  the  number  of 
car  miles  run  or  the  investment  per  revenue  passenger.1  The 
first  does  not  consider  the  number  of  persons  or  the  length  of 
mileage,  but  does  give  us  the  total  amount  of  traffic  on  a  unit 
basis.  The  number  of  passengers  to  the  number  of  car  miles, 
gives  an  indication  of  the  effectiveness  with  which  the  system 
is  used. 

While  an  analysis  of  density  will  show  the  general  strength. 
a  comparison  of  traffic  densities  on  street  railways  is  of  abso- 
lutely no  value  unless  the  variations  in  local  conditions  are  also 
considered.  Distribution  and  grouping  of  mileage,  size  and 
number  of  cars,  the  length  of  the  rides  on  the  different 
divisions  of  the  system,  and  transfer  privileges  given,  must  be 
known  before  any  comparisons  are  justified.  If  the  passengers 
travel  long  distances,  the  total  number  of  passengers  per  car 
mile  is  less.  On  the  other  hand,  a  system  on  which  the  passen- 
gers travel  short  distances,  and  on  which  the  cars  are  only 
partly  filled  but  constantly  reloaded,  would  have  a  large  average 
number  of  passengers  per  car  mile.3  Elevated  railway  cars  are 
a  good  deal  larger  than  surface  line  cars  and  equally  as  well 
crowded  during  the  rush  hours,  but  the  distance  traveled  by 
each  passenger  is  much  longer;  consequently,  the  number  of 
fares  paid  per  mile  of  track  may  be  even  less  on  elevated  roads. 
The  advantages  which  elevated  railways  possess  over  the  surface 
railways  which  have  long  hauls  are  the  grouping  of  trains  of  cars 
and  the  greater  speed  at  which  they  can  run.  The  effectiveness 
with  which  the  two  latter  can  be  accomplished  will  determine 
the  number  of  passengers  per  car  mile.  If  the  proper  number 
of  passengers  per  car  mile  can  be  maintained,  it  is  then  obvious 
that  the  distance  traveled  will  be  of  no  direct  importance. 

The  Bureau  of  Fare  Research  of  the  American  Electric 
Railway  Association  says  concerning  the  lay-out  of  the  traction 


JD.  J.  McGrath,  Electric  Railway  Journal,  May  8,  1915,  and  July  8, 
1916. 

'Barclay,  Parsons  and  Klapp,  Report  on  Detroit  Street  Railway  ( Jan- 
uary,  1915),  p.  19,  shows  that  mere  size  of  the  city  may  not  insure  density 
of  traffic,  but  that  the  character  of  the  city  and  its  distribution  are 
equally  essential. 


STREET  RAILWAY  BONDS  337 

company  and  the  density  of  traffic:  "Traction  lay-outs,  aside 
from  their  operating  significance,  determine  the  proportionate 
parts  of  tangible  capital  investment  devoted  to  track,  struc- 
tures, rolling-stock,  power  plant,  car  stations,  and  other  equip- 
ment. .  .  .  Where  the  city  is  compact  and  the  flow  of  traffic 
general  and  uniform,  a  considerably  smaller  investment  is  re- 
quired per  dollar  of  gross  revenue  than  in  the  case  of  cities  in 
which  passengers  must  be  carried  long  distances  and  where  the 
traffic  originates  in  one  district  and  terminates  with  very  little 
local  traffic  in  another  district.  The  length  of  transmission 
and  distribution  system  is  dependent  upon  the  physical  lay-out 
of  the  tracks.  The  expenditures  for  power,  equipment  and 
cars  are  primarily  influenced  by  the  extent  of  the  peak  hour 
service.1  It  is  not  at  all  unusual  for  a  company  to  have  service 
during  a  period  of  say  thirty  minutes  of  the  day  in  which  the 
maximum  generating  equipment  requirements  are  four  times 
as  great  as  would  be  sufficient  to  handle  the  business  if  it 
were  uniformly  distributed.  The  peak  load  also  determines  the 
amount  of  investment  in  car  and  car  storage  facilities."8 

Special  Problems  of  the  Interurban. — Though  many  of  the 
tests  used  in  the  analysis  of  the  interurban  company  are  the 
same  as  those  used  in  analyzing  the  urban  trolley,  there  are  a 
number  of  conditions  peculiar  to  the  interurban  which  must  be 
analyzed  quite  apart  from  the  urban.  The  greater  part  of  the 
interurban  systems  in  the  United  States  have  been  established 
since  1900.  But  so  rapid  has  been  their  development  that  they 
have  offered  serious  competition  to  the  local  railroad  traffic  in 
a  number  of  localities,  as  the  Nantasket  Beach  System,*  and  the 
Waterloo  and  Cedar  Falls  Railway.  A  number  of  short  local 
railroads,  unable  to  meet  competition,  electrified  their  right  of 


1What  is  said  in  detail  upon  the  peak  load  in  the  chapter  on  Electric 
Light  and  Power  Securities  applies  equally  well  to  what  is  referred  to 
here  concerning  the  influence  on  the  peak  load.  Peak  load  is  defined  here 
as  the  period  of  day  through  which  the  street  railway  has  its  heaviest 
traffic. 

2F.  W.  Doolittle  (Director) ,  Studies  in  the  Cost  of  Urban  Transporta- 
tion Service  (1916),  p.  8. 

"This  subsidiary  of  the  New  Haven  System  which  electrified  this 
branch  in  1895,  was  probably  the  first  of  the  interurbans  of  any  size  to 
adopt  electrification. 


338  INVESTMENT  ANALYSIS 

way,  and  several  of  the  larger  railroads,  fearing  the  complete 
withdrawal  of  their  local  traffic,  acquired  control  of  competing 
lines.  This  was  done  more  completely  in  New  England  by  the 
New  York,  New  Haven  and  Hartford  Railroad  than  in  any 
other  district  of  the  country,  though  these  acquisitions  have 
since  passed  over  to  the  control  of  another  company. 

At  present,  more  than  two-fifths  of  the  electric  railway 
trackage  is  outside  of  municipal  boundaries.  One  may  now 
travel  by  continuous  passage  over  electric  railways  from  Chi- 
cago or  St.  Louis  to  Detroit  and  Buffalo,  and  the  trip  can  be 
continued  from  Buffalo  to  New  York  City,  with  but  few  breaks. 
Interurban  service  has  become  so  efficient  under  the  consolida- 
tions of  the  last  ten  years,  that  one  may  travel  from  Danville  to 
Springfield,  Illinois,  and  from  Springfield  to  St.  Louis  by 
sleeper  with  the  same  facility  and  almost  the  same  rapidity  as 
by  railroad.  Private  rights  of  ways  have  been  secured,  which 
have  enabled  these  systems  to  offer  real  competition  to  the  rail- 
roads in  their  service  over  considerable  distances. 

The  lines  in  southeastern  New  York,  New  Jersey,  and  Penn- 
sylvania and  especially  in  New  England,  as  Mr.  Lawrence 
Chamberlain  has  pointed  out,  have  reached  the  saturation 
point,1  i.  e.,  of  intensive  development.  Eemote  districts  have 
been  made  easily  accessible,  and  conveyances  which  were  used 
in  reaching  railroads  have  been  supplanted  by  the  trolley.  This 
saturation  point  in  interurban  traffic  also  exists  in  the  immedi- 
ate vicinity  of  cities  like  Chicago,  Cleveland,  and  Los  Angeles. 
The  trolley,  however,  by  making  these  remote  areas  more  access- 
ible to  the  railroads  has  stimulated  the  habit  of  travel,  a  state- 
ment which  is  verified  by  the  increase  in  passenger  earnings  of 
railroads  located  in  these  areas.  The  majority  of  strictly  inter- 
urban systems  which  have  endeavored  to  secure  freight  and 
express  traffic  in  competition  to  the  railroads  have  been  those 
west  of  the  Alleghenies.  This  has  been  especially  true  of  the 
local  and  small  package  freight  which  constitutes  a  consider- 
able proportion  of  all  local  freight.  The  systems  of  Illinois, 
Indiana,  Michigan,  and  especially  Ohio,  have  far  exceeded  in 


1Lawrenee    Chamberlain,    Principles    of  Bond    Investment    (1911), 
pp.  322-327. 


STREET  RAILWAY  BONDS  339 

this  development,  and  it  has  been  in  these  areas  that  the  com- 
petition in  the  longer  distance  travel  with  railroads  has  been 
keenest.  Automobile  competition  is  also  becoming  more  impor- 
tant. For  example,  Mohawk  Valley  in  New  York  has  suffered 
from  such  competition. 

Despite  the  perfection  in  long-distance  through-service,  the 
great  majority  of  interurban  traffic  is  still  local.  Considerable 
dispute  has  arisen  among  the  traffic  managers  as  to  whether  the 
now  profitable  local  traffic  might  not  be  sacrificed  in  the  effort 
to  increase  the  long  distance  traffic.  The  maximum  distance  of 
500  miles  now  generally  accepted  will,  in  the  course  of  time,  no 
doubt  be  changed.  But  evidence  seems  to  indicate  the  necessity 
of  careful  discrimination  lest  the  effort  to  secure  long  distance 
traffic  be  too  costly.  Not  more  than  25  per  cent  of  the  traffic 
of  limited  cars  is  made  up  of  trips  of  more  than  sixty  miles. 
Many  roads  do  not  show  more  than  an  average  of  ten  miles,  and 
the  experience  of  all  interurbans  is  that  the  rural  population 
rides  the  shorter  distances. 

The  majority  of  the  interurban  railways  of  the  United  States 
may  be  divided  into  three  general  geographical  groups:  first, 
those  of  New  England,  Southeastern  New  York,  New  Jersey, 
and  Eastern  Pennsylvania;  second,  those  of  "Western  Pennsyl- 
vania, Ohio,  Indiana,  Southern  Michigan,  Illinois,  and  Southern 
Wisconsin;  third,  those  of  the  Pacific  Coast  which  has  three 
groups  centering  in  Los  Angeles,  San  Francisco,  and  Tacoma 
and  Seattle,  Washington,  respectively.  A  study  of  the  inter- 
urban railway  map  of  these  three  large  groups  shows  that  two 
influences  have  determined  the  location  of  interurban  systems 
in  the  country.  The  same  geographical  influences  which  gov- 
erned the  location  of  the  towns  and  cities  that  these  systems 
connect,  also  determined  the  direction  which  their  mileage  has 
taken.  Secondly,  every  important  system  enters  or  is  in  close 
transfer  connection  with  at  least  one  large  urban  center,  or  con- 
nects two  or  three  average  sized  cities. 

Whether  interurbans  are  located  in  a  manufacturing,  agri- 
cultural, or  mining  region,  the  necessity  of  one  important  ter- 
minal is  no  longer  disputed.  With  the  first  development  of  these 
systems,  it  was  thought  by  many  that  the  systems  in  Ohio  would 


340  INVESTMENT  ANALYSIS 

have  a  very  much  larger  earning  capacity  than  those  in  adjoin- 
ing states.  The  development,  however,  in  Indiana  and  on  the 
Pacific  Coast  shows  that  systems  in  agricultural  regions  with 
important  terminals,  will  be  used  as  much  as  those  in  manu- 
facturing centers.  Mr.  Gotshall,  in  a  lecture  at  Lehigh  Uni- 
versity, states  in  this  connection:  ''It  is  also  a  notable  fact 
that  the  less  the  population  per  mile  of  track  the  greater  will 
the  earnings  usually  be  per  capita.  In  other  words,  a  system 
operating  through  a  number  of  large  towns  will  not  get  as  much 
business  from  each  person  in  those  places  as  it  will  per  capita 
from  the  inhabitants  of  smaller  towns."  The  Fort  Wayne 
&  Wabash  Company,  even  with  direct  steam  competition,  does  a 
larger  part  of  the  local  passenger  traffic  than  do  the  railroads 
over  the  one  hundred  and  thirty-seven  miles  between  Indiana- 
polis and  Fort  Wayne.  The  Illinois  systems  of  well-balanced 
and  connected  lines  which  are  the  most  typical  of  extreme  inter- 
urban  development  compare  favorably  with  the  Ohio  systems. 

One's  first  impression  is  that  the  large  termini  furnish  the 
greater  part  of  the  traffic.  Within  a  radius  of  three  or  four 
miles  of  the  city,  a  park  or  the  suburbs  may  materially  increase 
the  traffic,  but  beyond  this  point,  the  small  town  and  rural 
population  furnishes  the  greater  proportion  of  the  business. 
Los  Angeles,  which  probably  has  the  heaviest  traffic  of  the  inter- 
urban  systems,  is  an  exception  to  this  general  statement  con- 
cerning the  influence  of  the  suburban  territory  on  interurban 
systems.  Los  Angeles'  suburban  districts  are  unusual  in  num- 
ber and  extent  of  distribution,  a  condition  which  lengthens  the 
journey  as  well  as  extends  the  density  of  traffic. 

The  most  desirable  location  for  an  interurban  is  in  a  well- 
populated  territory  evenly  distributed  rather  than  in  one  with 
an  irregularly  distributed  population  which  necessitates  the 
operation  of  empty  or  partially  filled  cars  over  a  part  of  the 
mileage.  Unfortunately,  the  methods  of  obtaining  these  funda- 
mental facts  vary  so  widely  among  engineers  and  financial 
statisticians,  that  many  of  the  conclusions  often  drawn  from 
ill-selected  facts  gathered  by  inexperienced  men  are  not 
fundamental. 


1H.  C.  Gotshall,  Notes  on  Electric  Railway  Economics,  p.  9. 


STREET  RAILWAY  BONDS  341 

Without  adequate  facilities  for  entering  a  city,  the  advan- 
tages gained  by  profitable  traffic  through  rural  districts  may  be 
largely  discounted  because  of  the  charges  paid  to  the  urban 
traction  company  for  carrying  passengers  to  the  business  center. 
If  the  interurban  has  a  single  station  in  a  town  and  must  dis- 
charge its  passengers  there,  it  has  no  advantage  over  the  rail- 
road system  and  suffers  losses  from  the  lack  of  development  in 
interurban  traffic.  On  the  other  hand,  the  necessity  of  too  fre- 
quent stops  witiiin  a  city  will  cause  losses  in  long  distant  traffic 
unless  the  company's  own  private  right-of-way  is  secured.  An 
interurban  which  had  a  profitable  rural  business,  but  was  com- 
pelled to  pay  exorbitant  charges  for  trackage  rates  into  a  town, 
was,  as  a  result  of  this,  forced  into  bankruptcy,  and  then 
acquired  by  the  urban  company.  Where  a  contract  exists  that 
gives  an  interurban  favorable  trackage  rates  within  a  large 
terminus,  all  the  terms  of  this  contract  should  extend  beyond 
the  life  of  the  bonds.  If  the  same  company  owns  both  the 
urban  and  interurban  lines,  it  has  an  added  advantage,  provided 
the  urban  company  does  not  exist  as  an  independent  company 
and  charge  the  interurban  company  exorbitant  prices  for  the 
right-of-way  in  the  city  for  terminal  facilities.  However,  such 
a  system  cannot  strictly  be  called  an  interurban  railway.  Care- 
ful scrutiny  of  both  terminal  facilities  and  right-of-way  charges 
should  be  made  before  proceeding  very  far  in  the  examination 
of  any  interurban  property. 

The  gross  income  of  street  and  electric  railways  from  their 
freight,  mail,  and  express  business  in  the  United  States  accord- 
ing to  the  1917  census  was  3.7  per  cent,  and  from  their  pas- 
senger revenue  92.8  per  cent  of  their  total  income.1  If  the 
income  from  the  interurban  business  could  be  separated  from 
the  urban,  this  percentage  would  be  very  much  higher,  as 
practically  all  of  the  freight  and  express  business  is  carried  by 
the  strictly  interurban  systems.  Some  of  the  smaller  systems 
operating  in  strictly  rural  communities  and  having  no  impor- 
tant termini,  have  a  very  much  larger  proportion  of  freight 
business.  A  few  companies  have  added  considerably  to  their 
income  by  giving  special  service  for  the  delivery  of  fruit,  milk 


lUnited  States  Census  Bureau  of  Electric  Railways,  1917,  p.  73. 


342  INVESTMENT  ANALYSIS 

and   other   perishable   goods,   and  by   the   so-called   merchant- 
package  service. 

The  opinion  of  most  traffic  managers  is  that  interurbans, 
with  a  few  exceptions,  must  derive  their  chief  freight  income 
from  the  local  small  package  and  perishable  freight  for 
which  the  shippers  are  willing  to  pay  higher  charges.  The 
limited  trunk-line  mileage  of  interurbans,  as  compared  with 
railroads,  will  always  limit  the  amount  of  this  freight,  for  rail- 
roads can  handle  this  traffic  at  cheaper  costs.  Where  the 
demands  for  trunk-line  facilities  are  developed,  the  railroads 
themselves  will  doubtless  electrify  and  establish  connecting 
links  with  the  existing  interurbans  at  junction  points.  Under 
the  present  system,  trunk  line  service  developed  on  an  exten- 
sive scale  must  necessarily  cause  considerable  losses  and  disad- 
vantages to  the  present  local  traffic.  If  the  heavy  freight  traffic 
forms  a  considerable  percentage  of  the  business  of  a  company, 
there  is  more  danger  of  affecting  the  business  of  the  railroad 
by  competition  than  if  its  business  is  merely  passenger  traffic. 
If  an  extension  is  to  be  made  into  new  territory,  an  examina- 
tion must  also  be  made  of  facilities  already  existing  and  the 
possible  expansion  of  branch  systems,  of  the  number  and  in- 
crease of  population,  and  the  character  of  the  products  of  the 
territory  that  will  contribute  to  local  freight  traffic. 

Revenues  and  Costs  of  Operating. — The  ratio  of  earnings  to 
capitalization  will  become  increasingly  important  as  regulation 
of  public  utilities  increases,  as  it  undoubtedly  will.  Incident- 
ally, however,  it  is  hoped  that  this  regulation  in  a  number  of 
states  will  have  a  sounder  basis.  The  tendency  of  the  commis- 
sions and  courts  is  to  place  stress  on  the  relation  of  rates  to  the 
actual  investment  in  properties.  Eegardless  of  what  the  investor 
may  consider  an  equitable  relationship  of  rates  to  capitalization, 
or  whether  there  is  any,  under  present  tendencies  of  regula- 
tion, he  is  forced  to  recognize  the  emphasis  upon  valuation  as  a 
basis  for  rates.  Ever  since  the  elucidation  of  the  principle  of 
the  relationship  between  fair  rates  and  fair  values,  in  Smyth  vs. 
Ames,1  it  has  become  an  established  principle  and  there  has 
been  some  attempt  at  least  to  secure  equitable  returns.  Custom, 


JSmyth  vs.  Ames,  169  U.  S.  166,  544. 


STREET  RAILWAY  BONDS  343 

however,  tenaciously  clings  to  a  rate  created  with  the  street 
horse-car,  whose  tracks  were  constructed  with  the  outlay  of  a 
few  hundred  dollars,  compared  with  costs  now  ranging  up  to 
six  figures.  There  is  no  more  logical  reason  that  this  charge 
created  under  these  earlier  conditions  should  continue  than 
that  the  same  price  paid  for  a  lot  in  the  loop  district  of  Chicago 
fifty  years  ago  should  be  asked  for  this  lot  today.  Street  car 
lines  must,  for  the  best  interests  of  the  public,  always  remain  a 
monopoly,  but  with  the  restrictions  and  control  which  the  state 
or  municipality  exercises  over  charges,  some  elastic  and  equit- 
able relationship  must  be  made  between  fares  and  the  cost  of 
construction,  maintenance,  and  operation  that  will  yield  an 
equitable  return  to  the  owners.1  This  again  is  not  a  plea  for 
the  over-capitalized  traction  companies  of  which  there  are  a 
number  referred  to  later.  Fortunately,  the  pressure  of  increas- 
ing prices  during  the  War  period  and  following,  has  hastened 
the  education  of  the  public  to  this  fact.  With  some  form  of 
elastic  adjustment  between  these  two  factors,  the  bonds  of 
conservatively  managed  traction  companies,  as  a  class,  should  be 
excellent  investments. 

The  lack  of  sufficient  detailed  public  information  and  the 
wide  range  of  variant  conditions  affecting  this  transportation 
problem  make  any  comparisons  of  financial  operation  extremely 
difficult,  and  easily  subject  to  erroneous  conclusions.  The  tabu- 
lations of  the  United  States  Census  because  of  their  greater 
completeness,  though  entirely  out  of  date  when  issued,  offer 
the  best  guidance  for  general  approximations.  With  these 
general  standards  the  variations  of  a  particular  company 
can  be  much  more  easily  explained  and  interpreted.  Even 
with  very  complete  accounts,  comparative  studies  of  street 
railways  will  always  be  subject  to  much  more  severe  criti- 
cism than  are  the  comparative  studies  of  railroads,  as  street 
railways  are  strictly  local  in  character.  With  trunk-line  rail- 
roads entering  the  same  general  territory,  the  conditions  affect- 
ing the  transportation  problem  are  so  similar  in  character  that 
it  is  much  easier  to  standardize  results. 


1G.  H.  Davis,  The  Adjustment  of  American  Street  Railway  Rates  to 
the  Expansion  of  City  Areas,  in  Proceedings  cf  American  Street  Railway 
Association  (January,  1911),  p.  4. 


344  INVESTMENT  ANALYSIS 

The  total  operating  revenues  from  street-railway  operations 
in  the  United  States  have  had  a  remarkable  growth  since  1900. 
The  increase  shown  by  the  United  States  in  1917  over  1902  was 
$462,271,083.  With  the  same  relative  growth  for  the  next 
decade,  the  income  from  street-railways  should  be  nearly  one 
billion.  The  Middle  Atlantic  and  East  North  Central  group 
of  states  have  shown  the  greatest  total  increase,  though  sta- 
tistics farther  west  have  shown  a  large  per  capita  increase. 
With  the  increasing  tendency  toward  consolidation,  there  has 
been  considerable  increase  in  the  income  from  light  and  power, 
but  as  these  have  not  been  separated  in  the  census  reports,  it 
is  impossible  to  make  an  accurate  separation  of  these  accounts. 

The  growth  in  absolute  amount  is  insignificant,  except  as 
compared  with  the  increase  in  the  net  profit.  By  the  many 
consolidations  and  mergers  between  1902  and  1912,  profits  were 
increased  through  better  utilization  of  plants,  and  the  savings 
in  administration  and  operation.  From  1912  to  1917  the  con- 
solidations or  purchases  by  holding  companies  were  not  large, 
though  still  very  important.  This,  and  the  increasing  costs  of 
operation,  have  checked  the  advantage  which  was  accruing  to 
the  traction  companies  in  their  large  unit  operations. 

The  Income  Statements  prescribed  by  the  Interstate  Com- 
merce Commission  and  adopted  by  the  American  Street  Eailway 
Association  are  the  same  for  urban  and  interurban  railways. 
These  prescribed  accounts,  however,  are  rarely  followed,  as  the 
Federal  government  does  not  exercise  jurisdiction  over  intra- 
state  business.  Consequently,  comparative  studies,  which  are 
only  possible  where  uniform  accounts  are  followed,  are  de- 
cidedly limited.  The  chief  headings  of  the  divisions  in  these 
statements  are  as  follows: 

INCOME  ACCOUNTS 

(Prescribed  by  Interstate   Commerce  Commission) 
(Only  General  Headings  Given) 

I — Operating  Income 

Revenue  from  Transportation 
Eevenue  from  Other  Railway  Operations 
II — Operating  Expense 

Way  and  Structure 
Equipmen* 


STREET  RAILWAY  BONDS  345 

Power 

Conducting  Transportation 

Traffic 

General  and  Miscellaneous 

Transportation  for  Investments  Cr. 

Net  from  Railway  Operations 
III — Auxiliary  Operations 

Auxiliary  Operating  Expenses 

Net  from  Auxiliary  Operations 

Taxes  Assignable  to  Railway  Operations 

Non-Operating  Income 

Deductions  from  Gross  Income 
IV — Net  Income  Transferred  to  Profit  and  Loss 

Except  for  the  sale  of  light  and  heat,  a  very  small  ratio  of 
the  revenue  of  electric  railways  comes  from  other  sources  than 
transportation.  In  consolidated  lighting  and  traction  com- 
panies in  urban  centers,  the  income  from  lighting  is  large.  In 
any  case,  both  the  revenue  and  the  expense  from  this  source 
should  be  clearly  separated  from  railway  operations.  Too  fre- 
quently the  sources  of  the  income,  as  well  as  the  expenses  of 
operation,  are  not  separated,  and  consequently  any  comprehen- 
sive study  of  these  reports  is  impossible.  Even  where  con- 
solidation of  urban  and  interurban  traction  companies  of  any 
magnitude  has  taken  place  and  there  is  a  separation  of  accounts, 
no  distinction  is  made  between  the  income  from  the  purely 
urban  and  interurban  properties.  In  some  instances,  the  sep- 
aration of  these  would  be  difficult,  as  the  rate  is  continuous, 
though  a  well-organized  system  should  provide  for  such  a  sepi 
aration  to  enable  the  company  to  determine  the  weakness  in  the 
operation  of  its  system. 

Although  approximately  sixty-five  per  cent  of  the  inter- 
urbans  carry  light  freight  and  express,  a  very  small  proportion 
of  the  gross  income  from  transportation  is  derived  from  this 
source.  The  electric  railways  of  Illinois,  Iowa,  Indiana,  Michi- 
gan, and  Ohio  far  exceed  those  of  any  other  group  of  states. 
The  average  of  these  states  will  range  between  seven  and  nine  per 
cent,  though  one  interurban  exceeds  fifty  per  cent.  Normally 
this  item  is  not  a  very  large  proportion  of  the  gross  income. 

The  standards  of  measurements  in  determining  the  efficiency 
of  earning  power  in  street  railways  can  be  applied  to  interurban 


346  INVESTMENT  ANALYSIS 

railways,  though  a  different  emphasis  will  be  placed  on  some  of 
the  units.  Length  of  mileage  and  size  of  the  chief  terminal 
rarely  show  any  direct  influence  upon  the  operating  revenue, 
but  revenues  have  a  very  decided  tendency  to  vary  with  the 
number  and  distribution  of  the  rural  and  small  town  popula- 
tion.1 If  a  company  varies  from  this  normal  tendency,  the 
reason  should  be  found,  to  ascertain  whether  there  is  the  same 
basis  for  permanency  in  revenue  as  under  the  established  rule. 

Other  income,  as  in  every  income  statement,  should  be  added 
after  the  deduction  of  administration,  operating,  maintenance, 
depreciation,  expenses,  etc.  In  holding  companies  the  income  is 
from  the  securities  of  subsidiaries,  a  fact  which  necessitates  an 
analysis  of  all  the  individual  companies.  The  meagerness  of 
the  public  utility  holding  company  reports  is  a  common  fault, 
and  unless  the  reader  is  well  versed  in  the  intricacies  of  finan- 
cial reports,  he  will  find  his  greatest  danger  of  error  in  the  in- 
terpretation of  these  statements.  Other  income  from  security 
holdings  is  usually  not  large  in  traction  companies,  only  amount- 
ing to  between  3  and  3.5  per  cent  of  the  total  income  for  all 
street  railways  of  the  United  States. 

The  ratio  of  the  items  making  up  the  total  operating  expense 
tabulated  by  the  Federal  Census  Bureau  is  instructive,  though 
not  absolute  for  the  particular  corporation. 

PEE  CENT  OF  DISTRIBUTION  OF  OPERATING  EXPENSES 

ACCOUNT  PER  CENT  OF  DISTRIBUTION 

1917  1912  1907  1902 

Operating  Expense  Total  100  100  100  100 

Way  and  Structure 12.2  13.3  11.3  10.48 

Equipment  10.8  11.6  12.5  11.72 

Power   17.0  16.1  17.5  16.83 

Traffic  0.5  0.81  0.7              0.79 

Conducting  Transportation 38.7  38.8  38.7  42.83 

General  and  Miscellaneous 13.9  15.1  16.8  17.35 

Auxiliary  Operations  Expenses ...  6.9  4.3  2.5 

(United  States  Census,  Electric  Railways  [1917],  p.  79  and  Census 
of  1912.) 


*Mr.  Louis  E.  Fischer,  Economics  of  Interurban  Railways,  pp.  23-28, 
assumes  that  the  gross  revenue  per  capita  varies  directly  with  the  size  of 
the  intermediate  towns.  Though  this  does  not  work  out  absolutely,  there 
is  at  least  always  a  tendency  towards  it. 


STREET  RAILWAY  BONDS  347 

These  items  commonly  fluctuate  in  the  following  order: 
traffic,  power,  way  and  structure,  general  and  miscellaneous, 
conducting  transportation,  and  maintenance  of  equipment.  All 
items  since  1900  have  had  a  remarkable  increase  and  especially 
since  1914.  The  cheapened  methods  of  manufacturing  current 
and  the  consolidations  with  lighting  companies,  which  have  made 
possible  the  large  centralized  power  plant,  have  to  a  large  degree 
checked  increases  which  would  have  been  much  larger.  Cen- 
tralized power  plants  have  also  created  in  the  small  town  a 
market  for  electric  power  and  light  which  otherwise  would 
have  been  impossible,  and  thus  have  enlarged  income  and 
reduced  costs  by  larger  scale  production. 

The  factors  affecting  the  differences  in  maintenance  accounts 
are  less  important  in  interurban  than  in  urban  properties.  The 
line  of  least  resistance  in  topography  has  usually  been  followed 
in  the  building  of  urban  mileage,  and  this  has  very  materially 
lessened  both  the  initial  cost  of  construction  and  maintenance  of 
way.  While  inflation  in  construction  accounts  has  been  more 
prevalent  in  this  class  of  public  utilities,  the  variation  in  actual 
cost  of  construction  has  been  much  less.  Where  interurbans, 
in  recent  years,  have  been  building  more  permanent  structures 
and  double  tracking,  these  costs  have  materially  increased 
with  the  increasing  prices  of  materials.1  With  few  exceptions, 
the  majority  of  interurbans  will  never  be  warranted  in  follow- 
ing the  policy  of  railroads  in  making  as  large  outlays  for  per- 
manent construction. 

The  operating  expenses  should  fluctuate  to  some  degree  with 
the  differences  in  the  density  of  traffic,  but  not  in  the  same 
ratio.  An  interurban  system  with  double  the  traffic  density, 
but  traversing  a  level  country,  may  have  lower  maintenance 
costs  than  a  road  in  a  hilly  district.  The  same  statement  would 
apply  to  an  urban  company  located  in  a  hilly  city.  As  main- 
tenance charges  vary  somewhat  with  earnings,  a  comparison  of 
maintenance  charges  should  be  checked  with  the  earnings,  car- 
miles  operated,  and  character  and  amount  of  traffic.  The  char- 
acter of  the  latter,  with  one  or  two  exceptions,  is  not  the  per- 


'F.  W.  Doolittle,  Cost  of  Urban  Transportation  Service,  p.  46. 


348  INVESTMENT  ANALYSIS 

plexing  problem  that  it  is  in  the  study  of  railroads,  since  the 
traffic  is  principally  passenger.  The  equipment  of  an  interurban 
system  never  has  the  wide  variation  found  on  a  railroad,  though 
considerable  difference  may  be  found  in  the  equipment  of  two 
different  systems.  And  any  comparison  not  allowing  for  this 
difference  would  be  fallacious.  Frequency  of  car  trips,  speed, 
and  character  of  equipment  are  the  most  important  considera- 
tions. "With  the  heavy  interurban  cars,  the  number  of  passen- 
gers is  of  little  consequence  in  affecting  the  increased  cost  of 
equipment,  as  they  are  such  a  small  proportion  of  the  weight 
of  the  car.  With  the  old  light  wooden  cars,  this  was  an  impor- 
tant consideration.  Depreciation  of  plants  and  buildings,  in 
both  interurban  and  urban  properties,  can  be  calculated  at 
approximately  the  same  rate  for  all  practical  purposes.1  The 
interurban  overhead  wires  are  occasionally  subjected  to  severe 
storms  which  cause  large  losses.  If  a  system  is  peculiarly  sub- 
jected to  these  storms,  maintenance  allowances  should  be  aver- 
aged ever  a  long  period  to  cover  such  extraordinary  losses.  It 
is  still  problematic  whether  traction  companies  as  a  class  are 
spending  a  sufficient  amount  for  maintenance  charges.  Even 
allowing  for  the  lighter  traffic  carried  as  compared  with  rail- 
roads, railway  engineers  of  high  authority  maintain  that  inter- 
urbans  are  making  less  outlay  than  necessary.  This  conten- 
tion means  that,  in  the  future,  the  burden  of  the  operating  costs 
should  increase  on  a  number  of  systems,  if  the  efficiency  of 
operation  is  to  be  maintained.  Maintenance  of  way  is  directly 
affected  by  the  character  of  the  track  and  topography  of  the 
territory  traversed.  The  same  difference  would  not  exist  be- 
tween two  interurbans,  one  traversing  a  level,  and  the  other  an 
uneven  country,  as  between  railroads  in  the  same  territory. 
The  heavy  traffic  of  railroad  trains,  which  is  such  a  heavy 
charge  on  maintenance  in  hilly  and  mountainous  regions,  does 
not  exist  to  the  same  degree  on  interurbans,  because  of  the  light 
traffic  of  the  single  car  system.  The  maintenance  for  a  single 
track  will  range  from  $700  to  $2,000  per  mile  of  track.  The 
principles  affecting  a  comparison  of  costs  and  the  probable  effect 
of  valuation  by  Public  Utility  Commissions  as  applied  to  urban 

*See  Topic  on  Depreciation. 


STREET  RAILWAY  BONDS  349 

street  railway  securities  are  also  applicable  to  interurbans.  The 
wide  variation  indicates  the  necessity  of  carefully  scrutinizing 
the  item.  The  other  difficulty  of  establishing  any  absolute  costs 
is  apparent,  of  course,  from  the  rapidly  changing  price  of 
material.1 

To  make  any  general  approximation  of  the  property  costs 
carried  on  the  company's  balance  sheet,  it  is  necessary  to  pro- 
cure some  idea  of  the  franchise  and  city  ordinance  requirements 
and  the  general  conditions  applicable  to  paving,  etc.,  in  the 
municipality  in  which  the  trolley  system  is  located.  The 
amount  of  any  new  issues,  of  course,  is  wholly  dependent  upon 
the  relation  of  this  property  account  to  the  existing  earnings  of 
the  company. 


'Mr.  Gotshall  approximated  the  maximum  and  minimum  cost  per 
mile  of  interurbaus  centering  in  large  cities  to  range  from  $27,796  to 
$90,623.  (W.  C.  Gotshall,  Electric  Railway  Economics,  p.  52.)  Mr. 
Gonzerbach  estimated  the  cost  of  interurbans,  inclusive  of  side  tracks,, 
etc.,  exclusive  of  the  right-of-way,  franchises,  legal  expense  and  interest 
charges  during  the  period  of  contract,  at  $29,750  per  mile.  (Ernest 
Gonzenbach,  Engineering  Preliminaries  for  Interurban  Electrics,  re- 
printed from  Street  Railway  Journal,  Apr.  4,  1913.)  Mr.  Fischer  in  his 
estimate  of  average  conditions  establishes  a  minimum  of  $25,720  and  a 
maximum  of  $58,650,  with  an  average  of  $35,000.  (Louis  E.  Fischer, 
Economics  of  Interurban  Railways  [1914],  pp.  96-98.)  Since  these  figures 
were  made,  the  large  increase  in  costs  would  require  additions  to  these 
estimates. 

Urban  costs  vary  much  more  widely,  as  expressed  in  the  costs  given 
below,  but  again  the  reason  for  these  differences  is  obvious  with  the  dif- 
ference in  paving,  underground  and  overhead  trolley  systems,  etc.  The 
Chicago  Council  Committee  reported  the  cost  of  construction  of  New 
York  companies  per  mile  to  be:  for  surface  roads  (including  paving) 
$80,000  to  $120,000;  elevated  (single  track)  $200,000  to  $300,000;  sub- 
ways, $600,000  to  $900,000;  river  tunnels  for  subways,  $1,200,000  to 
$1,800,000.  (Municipal  Reference  Library  of  the  City  of  Chicago.  Ref- 
erence Bulletin  No.  30  prepared  under  the  direction  of  Theodore  K.  King. 
A  Study  of  Rapid  Transit  in  Seven  Cities  [July,  1914]  p.  27.)  W.  S. 
Twing,  former  Chief  Engineer  of  the  Philadelphia  Transit  Bureau,  esti- 
mated the  costs  for  that  city  for  surface  lines  to  be  from  $30,000  to 
$50,000;  open  floor  elevated.  $300.000  to  $400.000;  solid  floor  elevated. 
$550,000  to  $700,000 ;  subways,  $2.000,000  to  $4,000,000.  William  Barclay 
Parsons,  former  Chief  of  New  York  City  Rapid  Transit  Bureau,  esti- 
mated .the  cost  of  surface  lines  at  $50,000;  elevated  $500,000,  and  sub- 
ways (single  track)  $1,000,000.  (Address  before  the  City  Club  of  Phila- 
delphia, May  6,  1912. )  The  Chicago  Council  Committee  gave  for  its  esti- 
mates as:  suburban  (no  paving)  at  $25,000;  city  trolley  (2  feet  paving) 
$42.000;  underground  trolley  (as  New  York).  $126.000,  and  Washington 
for  the  same  $48.500;  elevated  (to  meet  Public  Service  Commission's  re- 
quirements) $126.000;  elevated  (with  masonry)  $330.000;  subways  from 
$402,000  to  $2,700.000  (for  those  under  water  ways).  (Municipal  Ref- 
erence Bureau  [Chicago],  p.  11.) 


CHAPTEE  XIX 


(Continued) 

Technical  Units  of  Measurement  and  Comparison. — As  with 
other  public  utilities,  it  is  desirable  to  have  such  standard 
technical  units  of  comparison  as  will  assist  in  a  comprehen- 
sive interpretation  of  the  street  railways'  status.  When, 
however,  these  units  of  measurement  are  employed  for  com- 
parative purposes,  caution  must  be  used  in  accepting  the 
conclusions.  Conditions  affecting  every  company  vary,  and  any 
result  must  be  interpreted  according  to  these  modifications; 
otherwise  these  units  of  measurement  are  entirely  specious. 

Any  unit  measurements  used  must  first  necessarily  have  to 
do  with  the  relation  of  the  community  to  the  traction  company. 
These  tests  should  indicate  how  effectively  the  services  of  the 
trolley  are  being  utilized  and  what  potential  possibilities  exist 
for  the  future  development  of  the  company's  existing  plant 
and  subsequent  expansion.  The  character  of  the  community 
and  the  riding  habits  of  the  people  must,  of  course,  be  used  in 
the  interpretation  of  these  facts.  The  more  general  of  these 
tests  are  earnings  per  capita  (of  the  area  served),  gross  earn- 
ings per  mile  of  track,  and  density  and  diversity  of  travel. 
The  limitations  and  possibilities  of  these  tests  have  already 
been  given  under  the  general  discussion  of  density  of  traffic. 
Diversity  of  traffic  is  obtained  by  dividing  the  maximum  load 
carried  by  the  average  load  carried.  These  two  latter  require- 
ments give  the  effective  utilization  of  the  plant  and  are  the 
controlling  factors  in  the  cost  of  operating  the  trolley  system. 
It,  however,  requires  some  experience  to  use  this  latter  test 
safely,  as  experience  is  the  only  safe  guide  to  an  understanding 

350 


STREET  RAILWAY  BONDS  351 

of  the  qualifying  conditions.  The  total  number  of  revenue 
passengers  compared  with  growth  in  capitalization  and  mileage 
will  also  give  a  general  estimate  of  the  growth  of  the  organi- 
zation. 

The  physical  measurements  of  traffic  for  general  statistics 
are  the  most  effectively  secured  in  the  mile  unit  of  track 
measurement  of  income,  etc.,  as  with  steam  railroads.  The  two 
other  common  units  used  with  traction  companies  are  the  car- 
hour  and  the  car-mile  units.  The  car-hours  are  the  hours  the 
cars  are  actually  out  in  service.  The  car-hour  is  assumed  on 
the  basis  that  most  operating  expenses  continue  when  the  cars 
are  out,  regardless  of  whether  they  are  blocked  or  in  active 
motion.  On  the  other  hand,  it  does  recognize  speed,  for  if  a 
car  doubles  its  speed,  the  earnings  per  car-hour  correspondingly 
increase.  It  gives  an  excellent  unit  for  comparison  of  earnings. 
The  car-miles  are  most  accurately  obtained  by  procuring  the 
number  of  miles  each  particular  car  runs.  The  car  mileage  is 
a  direct  reflection  of  the  earnings  of  the  cars  in  active  service. 
Car  mileage  is  not  the  most  exact  criterion  of  expenses,  as  costs 
go  on  even  if  the  car  stops  or  is  delayed  on  its  route  before 
reaching  its  destination.  Car  mileage,  however,  is  the  unit  most 
commonly  used  and  for  most  purposes  serves  as  the  best  avail- 
able unit  of  measurement. 

Earnings  and  costs  for  financial  purposes  are  adequately 
tested  by  measuring  the  total  and  individual  items  to  the  mile 
of  track,  the  car-mile,  the  car-hour,  and  revenue  passenger. 
The  car-mile  unit  varies  both  with  the  distance  traveled  and 
the  car-capacity.  As  the  latter  varies,  the  unit  of  measurement 
is  not  constant.  As  some  of  the  elements  of  costs  vary  directly 
with  the  car-hour,  such  as  the  services  of  conductors  and 
motormen,  the  car-hour  is  a  useful  measurement  of  costs.1  More 


*Mr.  Fischer  (Ibid,  pp.  34-35)  found  the  range  of  operating  revenue 
of  iuterurbans  in  a  study  of  thirty-six  companies  to  be  from  $7  to  $13 
per  capita,  with  twenty-one  of  these  between  $8  and  $10  per  capita.  He 
states  further  that  where  two  large  cities  are  less  than  forty  miles  apart, 
the  per  capita  return  from  the  second  terminal  will  range  between  $6 
and  $20,  and  with  each  additional  ten  miles,  the  revenue  will  decrease 
10  per  cent.  This  range  usually  increases  with  the  relative  importance 
of  one  terminal  over  the  other,  and  if  they  are  both  small  cities  and  of 
approximately  the  same  size,  the  range  will  reach  the  lower  figure. 


352  INVESTMENT  ANALYSIS 

careful  consideration,  especially  with  interurbans,  must  be  given 
to  the  distribution  of  population  than  to  the  actual  size  of 
terminals  or  amount  of  population.  The  revenue  standard  unit 
is  also  influenced  by  limitations  which  must  be  used  in  apply- 
ing any  comparisons.  A  uniform  length  of  ride  is  assumed 
with  the  revenue  passenger,  although  this  condition  is  not  true 
of  the  suburban  extensions  and  the  interurban  traffic.  When 
zone-rates  are  used  in  interurban  lines,  this  is  partially  offset, 
though  the  average  length  of  ride  is  longer.  More  than  one- 
half  of  the  companies  under  their  original  franchises  have  been 
forced  to  extend  the  length  of  ride  with  the  extension  of  the 
limits  of  the  cities'  boundaries.  A  larger  use  of  the  transfer 
also  reduces  the  actual  number  of  revenue  passengers,  though 
the  total  traffic  statistics  might  remain  the  same.  The  length  of 
ride  will  be  reflected  in  the  reduction  of  the  passenger  rate  per 
mile,  which  will  reflect  the  weakening  condition  of  the  company 
unless  offset  by  other  factors.1 

The  same  measurements  can  be  applied  to  costs,  though  the 
same  limitations  must  be  accepted  in  the  interpretations  of 
their  value,  as  with  the  operating  revenues.  If  in  the  use  of 
the  passenger  unit,  the  average  haul  remains  constant  with  the 
changing  conditions,  the  status  of  the  traction  company  as 
measured  by  this  unit  is  unchanged.  If  the  expansion  of  the 
mileage  or  expansion  in  traffic  forces  a  relatively  larger  part  of 
the  increase  within  one  or  two  hauls  (i.  e.,  trips  for  a  car)  for 
the  day,  the  extra  cost  involved  will  more  than  offset  the  in- 


Bion  J.  Arnold,  New  York  Subway  Report  to  the  Public  Service  Com- 
mission of  the  First  District  (p.  10),  states : 

"Every  car  operated  one  mile  will  entail  a  corresponding  mainten- 
ance, i.  e.,  the  unit  cost  per  car-mile  of  the  three  items  of  Maintenance  of 
Way,  Maintenance  of  Equipment  and  Power  Plant  is  practically  inde- 
pendent of  the  number  of  car-miles  operated  and  will  not  decrease  ma- 
terially as  car-miles  increase."  Further  he  adds:  "The  unit  costs  per 
car-mile  of  wages  and  power  supply  are  almost  constant,  which  means  the 
avoidance  of  running  empty  cars.  Such  items  as  wages  of  platform  men, 
etc.,  other  transportation  expenses,  and  general  expenses  vary  inversely 
as  the  car-miles  run." 

JAn  interesting  illustration  of  the  increase  of  these  costs  with  the 
extension  of  the  fare  limit  is  brought  out  in  the  City  of  Milwaukee  vs. 
T.  M.  E.  R.  &  L.  Co.,  10  W.  R.  C. 

See  also  D.  C.  Jackson,  Street  Railway  Fares  in  Their  Relation  to 
Length  of  Haul  and  Costs  (1917).  Chaps,  iv  and  v. 


STREET  RAILWAY  BONDS  353 

crease  in  revenue.1  For  illustration,  if  the  income  of  a  trolley 
system  were  $500  and  the  maximum  requirement  of  cars  were  10, 
in  any  one  hour,  this  would  be  the  maximum  number  of  cars 
needed.  Suppose  the  revenue  of  this  same  company  increased 
to  $1000,  but  the  maximum  number  of  cars  needed  in  the 
highest  rush  hour  was  25 ;  then  this  company,  other  things  being 
equal,  is  not  as  well  cff. 

The  car-hour  like  every  other  unit  of  measurement  is  unsafe 
if  used  as  a  single  unit,  though  it  does  have  peculiar  value  in 
measuring  labor  costs  and  in  showing  the  relative  efficiency  of 
motormen  and  conductors.  The  car  mile  varies  with  the  size 
of  the  car,  the  conditions  under  which  it  is  operated,  and  the 
speed  of  the  car — all  of  which  limitations  must  be  accounted  for 
in  using  this  measurement. 

Operating  ratios,  which  are  so  commonly  used,  as  empha- 
sized in  the  chapter  on  the  Corporation  Report,2  are  significant, 
though  often  misleading  to  the  uninitiated.  The  errors  or  dif- 
ferences either  way  will  probably  make  the  ratio  for  the  street 
railways  of  the  United  States  a  fair  average  standard.  Accord- 
ing to  the  Federal  Census  Bureau,  all  street  railways  of  the 
United  States  show  an  operating  ratio  of  63.8  per  cent  for  1917, 
58.7  per  cent  for  1912,  and  61.1  per  cent  for  1907."  In  the 
street  railway  census  of  1917  approximately  two-thirds  of  the 
states  had  operating  ratios  ranging  from  53.7  to  65.3  per  cent. 
In  a  study  of  forty  street  railways  made  by  the  Electric  Rail- 
way Journal  on  the  basis  of  the  McGraw  Electric  Manual,  the 
range  of  operating  costs  for  surface  railways  was  from  45  to  75 
per  cent  of  gross  earnings.'*  Since  1917,  the  upward  movement 
of  costs  has  increased  these  ratios. 

Where  consolidation  has  been  effected  with  electric-light  and 
power  companies,  this  percentage  has  been  decreased,  and  well- 
managed  companies  under  normal  conditions  should  show  less 
than  60  per  cent.  The  majority  of  the  strictly  street  railway 
companies  have  operating  costs  ranging  between  60  and  70  per 

1 American  Electric  Railivay  Association  fear  Boole,  1914-1915,  p.  303, 
2See  topic  Operating  Ratio  in  Chap,  v,  on  Corporation  Report., 
"United  States   Census  Bulletin,  Electric  Railways  Bulletin,   1917, 
p.  91. 

'Electric  Railway  Journal  vol.  xlii  (Oct.,  1913),  p.  925. 


354  INVESTMENT  ANALYSIS 

cent  of  gross  earnings.  Street  railways  in  cities  over  100,000 
with  operating  ratios  over  70  per  cent  are  usually  very  small 
companies,  or  operate  in  the  outskirts  of  the  city.  Operating 
ratios  are  usually  lower  in  large  cities  than  in  smaller  cities,  as 
the  density  varies  with  the  population.  The  more  expensive 
costs  of  operation  and  higher  wages  in  the  city;  are  in  a  meas- 
ure offset  by  the  larger  number  of  passengers  per  mile  of 
track.1  Further,  where  density  is  great,  the  operating  ratio 
is  small  and  the  fixed  charges  are  large.  The  same  is  true  in  the 
comparison  of  the  number  of  passengers  carried  per  car-mile. 
Elevated  and  subway  railways  should  have  a  much  lower 
ratio  of  operating  expenses  than  surface  lines,  though  there  is, 
as  a  matter  of  fact,  no  common  experience.2  They  are  not  sub- 
ject to  expensive  blockades,  snow  storms,  etc.,  as  are  the  sur- 
face trolleys,  and  a  considerable  savings  in  some  systems  is 
also  realized  by  large  cars  and  long  trains,  though  this  is  offset 
to  some  extent  by  the  cost  of  stations.  The  required  length  of 
haul,  especially  where  the  population  density  is  small,  is  becom- 
ing a  serious  burden  to  elevated  systems,  though  the  same  diffi- 
culties exist  in  surface  lines  which  are  over-extended,  and 
where  one  fare  is  charged  and  a  large  number  of  transfers  are 
used.  Short  hauls  through  a  densely  populated  territory  should 
always  have  the  lowest  operating  ratios,  as  heavy  traffic  usually 
results  in  large  earnings  per  car-mile.  In  cities  over  four 
hundred  thousand  the  constant  obstructions  to  traffic,  where 
traffic  regulations  are  not  very  efficiently  managed,  may  in- 
crease wage  charges  by  retarding  the  speed  of  cars,  though 
the  increased  density  usually  tends  to  offset  this  increased  cost. 


United    States   Bureau   of   Census   Street   and  Electric   Railways 
(1915),  p.  263. 

2The  comparisons  of  the  Boston  traction  companies,  as  illustrating 
the  difference  in  costs,  are  interesting. 
Way  and 

Structure        Receipts        Car  Mile  Operating  Exp. 
Per  Car  Mile  Per  Car  Mile  Run  Costs       to  Gross 

Surface  Lines  3.19  32.9  22.1  67.1% 

Rapid  Transit  Lines  . .     2.09  28.4  15.5  54.5% 

(John  A.  Beeler,  Report  on  the  Methods  and  Practices  of  Boston  Elevated 
Railway  Company,  Boston,  Massachusetts,  to  the  Public  Service  Com- 
mission, Commonwealth,  Massachusetts,  November,  1917.) 


STREET  RAILWAY  BONDS  355 

The  constancy  between  the  averages  of  the  operating  items 
themselves  is  shown  in  the  five  different  census  averages,  with 
the  exception  of  way  and  structure  accounts,  which  indicate  a 
persistent  upward  trend  substantiating  the  contention  of  the 
increasing  amount  of  the  outlay  for  all  expenditures.  The 
aggregate  amount  of  the  operating  expense  has  experienced 
enormous  increases  in  both  material  and  labor  costs.  But  the 
persistency  of  these  ratios  argues  for  their  defense  as  an 
approximate  standard  in  analyzing  the  average  American  urban 
railway. 

Concerning  the  fixed  expense,  the  Fare  Research  Bureau  of 
the  American  Street  Railway  Association,  states: 

.  .  .  The  fixed  expenses  representing  capacity  may  be 
expected  to  vary  with  such  units  as  the  mile  of  single  track  and 
the  number  of  cars  owned.  Fixed  expenses  are  those  which  will 
accrue  in  practically  the  same  amounts,  whether  the  property 
is  operated  or  not.  Variable  expenses  are  those  which  vary  to  a 
greater  or  less  degree  with  changes  in  the  amount  of  service 
rendered,  and  may  be  expected  to  vary  with  such  units  as  the 
car  mile,  the  car  hour  and  the  number  of  passengers  carried. 
Ad  valorem  taxes  and  interest  are  examples  of  the  former,  while 
platform  wages  illustrate  the  latter.  As  applied  to  the  cost  of 
carrying  a  passenger,  total  fixed  costs  may  be  expressed  in 
passenger  units  and  variable  costs  in  passenger  mile  units. 

"The  ratio  of  variable  to  fixed  units  indicates  the  degree  to 
which  capacity  is  used.  The  number  of  car  miles  per  mile  of 
single  track  represents  the  density  of  service,  passenger  miles 
per  car  mile,  the  density  of  track,  population  per  mile  of  track, 
the  density  of  tributary  population,  and  number  of  passengers 
to  population,  the  number  of  rides  per  inhabitant,  or  riding 
habit  .  .  .  ' 

Capital,  Capitalization,  and  Property  Investment. — The 
variety  of  items  and  the  lack  of  uniformity  in  the  meaning  of 
these  items  give  a  rather  confused  understanding  of  the  finan- 
cial situation  of  street  railways,  unless  the  proper  interpreta- 
tion of  the  street  railway  report  in  question  is  known.  The  first 
important  deduction  in  the  balance  sheet  is  the  cost  of  construc- 
tion.  More  than  five-sixths  of  the  reported  assets  of  street  rail- 
ways are  included  in  the  items  "Cost  of  Construction  and 


356  INVESTMENT  ANALYSIS 

Equipment."  Many  companies  also  carry  their  franchises  as 
an  item  in  the  cost  of  construction.  But  the  difficulty,  and  a 
fact  that  must  be  constantly  borne  in  mind,  is  that  these 
costs  do  not  always  indicate  cash  outlays.  Large  increases  in 
franchise  items  have  resulted  from  the  consolidation  and  recon- 
solidation,  as  the  ''Cost  of  Construction,"2  will  indicate  in  a 
number  of  the  older  companies. 

Where  other  investments  are  carried  as  an  asset,  checks 
should  be  made  against  a  duplication  of  these  accounts.  The 
majority  of  these  securities  appearing  in  street  railway  state- 
ments are  the  securities  of  subsidiary  companies  which  are 
partly  or  completely  controlled  by  a  parent  company,  often  con- 
stituting a  separate  corporation.  As  a  consequence,  when  the 
financial  status  of  the  parent  company  is  affected,  the  securities 
of  the  subsidiary  company  or  companies,  which  are  only  a  part 
of  the  same  organization,  are  equally  affected. 

In  the  absence  of  information  on  the  capitalization  of  sub- 
sidiary companies,  the  funded  debt  might  seem  totally  insignifi- 
cant, when  as  a  matter  of  fact,  the  subsidiary  companies  were 
grossly  over-loaded.3  Advances  can  also  be  made  to  sub- 
sidiaries, a  practice  which  allows  a  continuous  pyramiding  of 
security  issues,  the  actual  amount  of  which  is  not  known  to  the 
investor.  The  practice  of  issuing  only  part  stock,  also  found  in 
the  simple  operating  company,  is  more  easily  obscured  in  the 
holding  company.  The  difference  between  the  par  value  of  the 
bonds  and  stocks  and  the  assets  of  the  company,  is  usually  made 
up  in  the  value  of  the  franchise,  as  the  net  quick  assets  are  rela- 
tively a  very  small  amount.  And  frequently,  the  investor  is 
ignorant  of  the  over-valuation  placed  upon  the  franchise 
because  of  the  failure  to  separate  the  franchise  from  other  asset 


^United  States  Census  Bulletin,  No.  124  (1914). 

zNo  estimates  of  cost  of  construction  can  be  used  for  comparative 
purposes  because  of  the  wide  variation  in  the  character  of  construction 
and  the  necessary  costs  due  to  the  difference  in  amount  and  character 
of  traffic.  Owing  to  the  emphasis  now  being  placed  upon  physical  valua- 
tion of  public  utilities,  a  knowledge  of  these  facts  is  important.  A  com- 
parison of  roads  under  similar  conditions,  if  they  can  be  found  and  if 
the  facts  are  carried  down  to  date,  will,  however,  not  only  give  light  as  to 
the  actual  outlays,  but  will  indicate  what  effect,  in  the  very  near  future 
at  least,  any  regulation  of  valuation  may  have  on  the  system. 

'See  chap,  iv,  Analysis  of  Corporation  Report. 


STREET  RAILWAY  BONDS  357 

values.  Where  the  company  is  highly  successful,  this  condition 
will  have  little  significance  compared  with  the  great  value  of 
the  company  as  a  going  concern,  but  when  the  value  is>  not  an 
assured  certainty,  it  becomes  exceedingly  important  whether  the 
capital  stock  has  been  fully  paid.  Again,  where  state  commis- 
sions are  putting  particular  emphasis  on  cost  values  in  relation 
to  rates,  the  full  knowledge  of  these  facts  is  imperative. 

A  detailed  study  of  the  United  States  Census  figures  shows  a 
very  large  over-capitalization  as  compared  with  the  steam  rail- 
roads of  the  country.  And  this  is  the  greatest  weakness  of  the 
street  railway  companies  as  a  class.  Individual  violations  of 
sound  financing,  as  with  all  classes  of  corporations,  are  appar- 
ent in  the  relation  of  funded  debt  to  capital  stock.  This  is  a 
remnant  of  the  older  method  of  financing  street  railway  prop- 
erty, but  is  now  considered  precarious  to  the  interests  of  both 
the  bondholders  and  stockholders.  The  companies  possessing  a 
large  percentage  of  funded  debt  and  which  have  not  been  forced 
into  receivership  have  been  largely  able  to  maintain  this  large 
fixed  charge  because  of  the  rapid  growth  of  the  city.  It  is 
highly  improbable  that  a  new  company  could  secure  its  capital 
on  that  basis  today,  though  a  number  of  companies  are  still 
yielding  to  the  questionable  practice  of  issuing  large  stock 
bonuses. 

In  states  where  corporations  are  rigidly  regulated  and 
security  issues  limited,  as  in  Massachusetts,  the  correct  propor- 
tion of  capitalization  may  be  violated  by  a  large  amount  of  cur- 
rent liabilities.  It  is  not  an  unusual  practice,  under  such  regu- 
lations, for  corporations  to  carry  a  considerable  amount  in 
promissory  notes  which  has  been  used  for  construction  pur- 
poses. The  high  rate  paid  for  short  loans  and  the  frequent 
renewals  or  settlements  make  this  method  of  financing  costly. 
However,  Massachusetts,  whatever  may  be  said  in  criticism  of 
its  early  legislation,  has  eliminated  to  a  considerable  degree 
many  of  the  objectionable  features  of  this  former  regulation  of 
financing  public  utilities. 

Large  allowances,  on  the  other  hand,  must  be  made  for  this 
over-capitalization  existing  among  electric  traction  companies. 
While  every  company  has  been  subject  to  a  large  number  of 


358  INVESTMENT  ANALYSIS 

varying  local  conditions,  all  properties  have  been  affected  by  the 
increased  costs.  The  increased  municipal  requirements  for  pav- 
ing, and  the  acquiring  of  other  than  railway  properties,  and 
the  rebuilding,  changing  and  improving,  on  the  company's  own 
initiative,  to  meet  the  demand  for  service  have  forced  enormous 
increases  in  investments.  The  total  expenditures  have  conse- 
quently often  been  larger  than  if  the  properties  were  now  con- 
structed new.  The  changes  have,  however,  usually  been  profit- 
able even  with  the  great  increase  in  fixed  charges  when  the 
savings  in  operating  are  taken  into  account.  But  there  has 
been  as  a  result  of  this  obsolescence,  a  considerable  and  neces- 
sary waste  of  capital.  And  it  might  be  well  here  to  emphasize 
the  fact  that  one  important  difficulty  with  a  number  of  com- 
panies is  their  failure  to  provide  for  obsolescence  out  of  earn- 
ings so  that  properties  long  passed  to  the  junk  heap  are  still 
carried  in  the  capital  account  and  covered  by  securities  out- 
standing. 

The  failure  to  provide  for  the  depreciation  of  this  obsoles- 
cent property  thus  causes  the  continuance  of  the  payment  of 
interest  and  dividends  upon  the  securities  representing  this 
discarded  property.  Fares  should  consequently  be  allowed  that 
would  enable  the  companies  to  make  provisions  for  the  changes. 
The  older  companies,  however,  without  exception,  regardless  of 
their  earnings,  paid  out  the  greater  part  of  the  earnings  in 
interest  and  dividends.  Surplus,  wherever  accumulated,  was 
used  in  the  extensions  of  new  lines.  Had  correct  accounting 
methods  been  practiced,  a  great  many  of  the  horse  and  cable 
railways  would  have  been  largely  written  off,  and  consequently 
the  large  increases  in  capitalization  would  have  been  obviated. 
But  with  the  rapid  changes  that  have  been  made  in  electrical 
transportation,  it  would  have  been  impossible  in  the  majority 
of  properties  to  make  allowances  for  the  depreciation  account 
and  provide  for  expansion  and  improvements,  without  endan- 
gering interest  and  dividends.  But  since  sufficient  experience 
has  now  been  attained  in  electrical  properties,  it  would  seem 
to  be  the  soundest  method  of  financing  to  reduce  as  rapidly  as 
possible  any  accumulations  of  depreciation. 

It  is  difficult  to  obtain  accurate  information  as  to  the  actual 


STREET  RAILWAY  BONDS  359 

cash  that  has  been  put  into  the  construction  of  electric  rail- 
ways. The  original  costs  of  construction  accounts  that  have 
been  carried  forward  in  the  balance  sheets  give  little  informa- 
tion and  little  assistance.  The  intermediate  construction  com- 
pany accounts  have  also  often  made  the  book  values  misleading. 
Consolidations  have,  however,  as  already  pointed  out,  been  the 
greatest  cause  of  the  inflation  of  costs.  The  cost  that  is  entered 
by  the  purchasing  company  is  the  price  paid  in  its  own  securi- 
ties. This  amount  is  usually  based  on  earning  capacity,  and  if 
the  railway  is  a  large  earner,  a  premium  price  above  the  capi- 
talized earning  price  is  usually  paid  to  obtain  control.  But,  as 
courts  and  commissions  in  their  decisions  of  valuations  are 
placing  emphasis  on  the  relation  of  capitalization  to  expendi- 
tures in  construction,  it  is  decidedly  important  that  this 
relationship  be  known  to  the  investor. 

According  to  the  United  States  Census,  the  capitalization  of 
street  railways,  as  a  class,  varies  with  the  size  of  the  city,  but 
not  at  a  proportionate  ratio.  Though  the  street  railways  in 
cities  under  25,000  do  not  seem  to  be  over-capitalized,  as  com- 
pared with  the  railways  in  cities  above  25,000,  the  small  per- 
centage of  these  properties  that  receive  any  dividend  returns 
shows  that  either  they  are  over-capitalized  or  are  not  receiving 
a  sufficient  rate  for  their  service. 

Depreciation. — It  was  not  formerly  customary  for  street  rail- 
ways to  provide  for  the  deterioration  and  obsolescence  of  physi- 
cal property.  This  practice  was  justified  on  the  basis  that  the 
appreciation  in  the  value  of  the  property  due  to  the  growth  of 
the  city  was  greater  than  the  actual  depreciation.  This  argu- 
ment was  used  to  vindicate  the  practice  of  issuing  new  capital 
to  the  amount  of  this  appreciation  when  replacements  and 
renewals  were  necessary.  Such  a  practice  cannot  now  long  con- 
tinue in  most  cities,  for  with  a  slowing  up  of  the  growth  of  urban 
population,  retardation  in  appreciation  will  take  place.  At 
the  present  too  many  systems  which  claim  to  maintain  a  depre- 
ciation fund,  set  aside  such  varying  amounts  that  the  average 
rate  is  inadequate.  Accountants  frequently  contend  that  with 
the  existing  capitalization  many  systems  could  not  provide  a 
proper  allowance  for  maintenance  and  depreciation  and  make 


360  INVESTMENT  ANALYSIS 

a  creditable  return  on  the  par  value  of  their  stocks.  The  Fed- 
eral tax  laws  will  eventually  correct  this  failure  to  allow  for 
depreciation  by  its  allowances  for  depreciation  deductions  in 
levying  taxes. 

Owing  to  the  rapidity  with  which  obsolescence  in  the  early 
organizations  forced  itself  upon  these  companies,  they  had  to 
make  new  capital  issues  which  on  the  face  of  the  meager  state- 
ments issued  by  these  traction  companies  seem  justified.  But 
had  the  complete  facts  concerning  these  earlier  street  railways 
been  published  at  the  time  of  the  new  capital  issues,  few  of  these 
issues  would  have  been  sold.  One  needs  to  make  only  a  cursory 
examination  of  the  United  States  Census  Bureau's  reports  on 
the  growth  of  mileage  and  capitalization  to  be  reminded  of  the 
force  of  this  statement.  At  the  present  writing,  with  the  con- 
tinuing high  costs  following  the  War,  the  situation  has  become 
extremely  acute  with  these  over-capitalized  companies.  At  best, 
the  situation  for  all  trolley  systems  is  bad  and  needs  correction, 
though  this  situation  must  not  inadvertently  be  made  the  pre- 
text for  a  continued  inflation  of  the  companies  which  have  been 
at  fault.  To  overlook  this  depreciation  means  an  even  greater 
obstacle  to  the  proper  recognition  of  depreciation.  This  state- 
ment does  not,  of  course,  imply  the  wholesale  condemnation  of 
all  traction  systems,  yet  we  must  not  approve  the  widespread 
recurrence  of  this  questionable  procedure  in  the  early  history 
of  traction  companies.  In  several  of  the  states  there  are  now 
statutes  requiring  the  setting  aside  of  a  definite  annual  amount 
for  depreciation. 

The  rate  of  depreciation  will  vary  with  the  age  of  the  prop- 
erty at  the  time  of  the  bond  issue,  the  length  of  the  haul,  char- 
acter of  equipment,  the  requirements  in  the  ordinance  concern- 
ing paving,  the  amount  of  traffic,  etc.  In  a  rapidly  growing 
city  obsolescence  has  been  a  greater  charge  than  actual  depreci- 
ation of  equipment.  The  Wisconsin  Commission  ruled  that  the 
rate  for  the  City  of  Milwaukee's  street  railways  should  be  at 
5.35  per  cent  of  the  value  of  the  depreciable  property  and  the 
net  on  the  entire  cost  of  the  physical  property  at  4.8886  per 
cent.1  On  the  basis  of  the  investigations  of  the  Committee  on 


Washington  Park  Advancement  Association,  etc.,  vs.  T.  M.  E.  R.  & 
L.  Co.,  13  W.  R.  C.  R.,  239. 


STREET  RAILWAY  BONDS  361 

the  life  of  railway  physical  property  of  the  American  Electric 
Railway  Association  and  the  foreign  associations  of  the  tram- 
ways, commissions  have  placed  the  rate  on  physical  property 
between  four  and  five  per  cent  of  the  cost  of  physical  property  or 
between  16  and  20  per  cent  of  the  operating  revenues.1 

The  Franchise.' — Insofar  as  the  financial  status  of  the  com- 
pany is  concerned,  it  is  essential  to  know  four  things :  first,  the 
duration  of  the  franchise;  second,  the  limitation  placed  upon 
the  charges  which  can  be  made;  third,  the  requirements  affect- 
ing the  company's  own  equipment  and  tracks,  and  amount  of 
paving,  etc.,  which  must  be  done  for  the  city;  and  fourth,  the 
reimbursements  which  must  be  made  to  the  city. 

The  duration  of  the  franchise  should  extend  for  some  period 
beyond  the  life  of  the  bonds.  In  practice  the  fulfillment  of  this 
requirement  is  not  so  simple,  because  of  the  complications  enter- 
ing into  the  holding  company  organization.  The  holding  com- 
pany issues  are  also  secured  by  subsidiaries.  It  is  not  unlikely 
that  the  franchise  of  some  of  these  subsidiaries  will  expire 
before  the  bonds  of  the  holding  company  are  due.  Conse- 
quently, the  property  values  and  the  earnings  of  the  subsidiary 
must  be  secured  and  its  relation  to  the  whole  then  determined 
and  deducted,  though  the  expiration  of  a  single  subsidiary  may 
not  be  so  important  where  public  relationships  have  been  cor- 
dial and  renewals  are  easy.  The  acceptance  of  the  principle  of 
the  monopoly  has  tended  to  diminish  the  former  importance  of 
duration  and  to  place  the  emphasis  upon  the  last  three  essentials 
of  the  franchise  given  above,  which  directly  affect  the  financial 
returns  of  the  traction  company. 

When  the  interurban  has  franchise  privileges  in  its  terminal 
cities  or  through  towns  and  cities,  the  same  requirements  apply 
as  with  franchises  of  purely  urban  systems.  If  a  right-of-way 
is  owned  the  same  general  regulations  apply  as  to  steam  rail- 
roads. Right  of  ways  are  commonly  owned  through  rural  ter- 
ritory, but  their  value  is  a  small  fraction  of  the  land  values 
owned  within  the  municipality. 


Bureau  of  Fare  Research  of  the  American  Street  Railway  Associa- 
tion, p.  63  (1916). 

2Delos  F.  Wilcox's  Municipal  Franchises,  vol.  ii,  on  Transportation 
Franchises,  will  be  found  particularly  instructive  in  the  study  of  the 
underlying  requirements  of  franchises. 


362  INVESTMENT  ANALYSIS 

The  chief  weakness  of  the  street-car  companies,  alluded  to 
so  frequently  in  this  chapter,  is  that  their  charges  are  fixed. 
(These  charges  are  always  stated  in  the  franchise.)  If  the  city 
limits  are  later  extended,  the  new  area  is  included  regardless  of 
its  extent  and  the  amount  of  traffic  which  it  will  furnish,  and 
the  possible  losses  which  the  company  may  suffer  by  giving 
transportation  facilities  to  this  new  area.  The  injustice  of  fix- 
ing for  all  time  a  rate  which  has  no  relation  to  costs  needs  no 
comment.  Why  should  a  custom-made  rate  of  half  a  century 
ago  continue,  if  it  involves  losses?  War  pressure,  which  has 
proved  such  a  burden  to  traction  companies,  has  hastened  a 
recognition  of  this  injustice  and  has  resulted  in  the  granting  of 
increased  rates.  Indirectly  this  injustice  is  also  recognized  in 
the  granting  of  equitable  returns  upon  the  investment.1  It  has 
been  unfortunate  that  the  over-capitalization  of  so  many  trac- 
tion companies  has  brought  about  a  confusion  of  the  real  issue 
of  fares  and  caused  the  conservatively  capitalized  and  managed 
traction  companies  to  suffer.  This  over-capitalization,  result- 
ing in  the  multiplicity  of  issues  and  consequent  over-issues 
through  the  holding  and  subsidiary  company  entanglements, 
should  be  remedied,  although  reduction  of  capitalization,  would 
not  itself  result  in  a  rate  adequate  to  yield  the  parent  company 
a  sufficient  return. 

The  agitation  for  low  rates  which  has  been  more  acute  with 
street  railways  than  with  any  other  public  utility,  was  started 
after  a  long  period  of  a  steadily  increasing  price  level.  In  these 
agitations,  as  a  class,  no  recognition  for  a  long  time  was  taken 
of  the  decrease  in  purchasing  power  of  the  nickel,  which  must 
either  force  a  reduction  of  the  quality  of  service  or  impoverish 
the  company.  This  does  not  argue  for  high  rates  for  public 
utility  service,  for  public  utility  charges,  because  of  the  com- 

JThe  Nebraska  Railway  Commission  in  1911  ruled  in  the  case  of  the 
Lincoln  Traction  Company,  that  an  8  per  cent  return  on  the  capital 
stock  was  not  excessive.  The  Washington  Commission  in  the  same  year 
held  that  7  per  cent  might  be  considered  fair  for  the  Pugest  Sound 
Electric  Railway  Company ;  in  the  Savannah  Electric  Company  case 
(Gas)  6.77  per  cent  was  not  considered  excessive;  the  New  York  Public 
Service  Commission,  2nd  District,  held  in  the  Rochester  decision  that 
8.58  per  cent  was  not  excessive;  and  New  Jersey  in  the  Trenton  Mercer 
Company  Corporation  ruled  that  7.37  per  cent  was  sufficient. 


STREET  RAILWAY  BONDS  363 

mon  dependence  of  modern  industrial  organization  upon  them, 
must  be  kept  as  low  as  is  possible  and  at  the  same  time  allow  a 
high  enough  return  upon  the  investment  to  invite  capital. 

The  demands  placed  upon  urban  railways  for  paving,  etc., 
have  greatly  increased  as  municipalities  have  developed.  Fran- 
chises also  include  clauses,  which  give  to  municipalities  the 
power  not  only  to  require  unusual  replacements,  but  actually 
to  change  the  conditions  of  the  franchise.  Pressure  of  public 
opinion  may  become  so  great  that  it  may  be  best  to  waive  the 
privilege  under  an  existing  charter,  and  procure  a  new  charter 
as  Chicago  City  Railways  did  in  1907.  The  yearly  income 
statement  should  be  sufficiently  detailed  to  give  one  an  accurate 
insight  into  the  importance  of  this  existing  burden,  though 
it  will  not  include  the  future  additional  burdens,  which  may  be 
added  by  authority  of  the  franchise. 

A  large  number  of  street-railway  franchises  call  for  a  divi- 
sion of  the  net  profits  with  the  municipality.  This  developed  as 
a  compromise  with  the  municipal  ownership  advocates,  but  this 
form  of  franchise  is  now  being  substituted  for  another  form 
referred  to  later.  The  franchise  should  be  carefully  examined, 
as  to  whether  the  city's  allotment,  within  the  life  of  the  bond 
issue,  to  be  purchased  will  be  increased.  A  detailed  study  of 
Chicago,  Cleveland,  and  Kansas  City  franchises  in  this  regard 
is  particularly  instructive. 

Regulation. — Regulation  of  public  utilities  has,  each  year, 
become  a  more  and  more  important  consideration.  "While  these 
regulations  embrace  all  features  of  service  and  operation,  as 
well  as  the  finances  of  the  utility,  the  investor  is  primarily  in- 
terested in  all  these  from  the  standpoint  of  their  effect  upon 
income.  With  forty-eight  different  states  having  power  to  regu- 
late, the  classification  of  all  the  variations  appearing  in  the 
statutes  of  these  states  becomes  impractical.  However,  the 
acceptance  or  rejection  of  the  more  fundamental  principles  un- 
derlying regulation  should  be  examined  by  the  investor,  as 
their  effects  upon  investment  values  are  of  large  importance. 

Before  commenting  on  the  form  and  tendency  in  regulation, 
two  things  should  be  observed  as  having  an  influence  on  the 
value  of  the  particular  regulation.  The  first  of  these  is  that  of 


364  INVESTMENT  ANALYSIS 

the  public  attitude  in  the  locality.  The  second  consideration  is 
that  of  distinguishing  between  the  security  issues  made  in  those 
states  which  have  already  adopted  far-reaching  regulatory 
measures,  and  those  which  have  been  issued  in  states  having 
limited  regulation.  Though  this  fact  may  seem  so  apparent 
that  it  does  not  warrant  comment,  thousands  of  investors  have 
passed  it  over  without  giving  a  single  thought  to  its  consid- 
eration. This  discrimination  must  be  made  as  long  as  such 
wide  differences  exist  as  to  what  standardization  includes  and 
means.  Where  statutory  regulations  are  still  meagre,  or  laws 
have  been  passed  but  not  tested  by  court  and  commission  deci- 
sions, sufficient  discount  of  their  future  influences  must  be 
allowed.  New  legislation  will  in  most  cases  tend  to  depress  tem- 
porarily security  prices  below  their  real  values,  but  securities  of 
sound  values  always  react.  To  the  shrewd  investment  pur- 
chaser, this  situation  offers  excellent  opportunities  for  pur- 
chases, as  the  market  sooner  or  later  discounts  these  conditions. 

While  a  corporation  which  has  a  monopoly  of  the  business 
should  be  required  to  render  as  cheap  service  as  possible,  it 
should  not  be  denied  a  legitimate  return  upon  the  capital 
invested  in  it.  This  is  not  only  an  injustice  to  the  security 
holder,  but  also  results  in  bad  service  to  the  public  and  discour- 
ages new  capital  from  seeking  investment.  And  sound  regula- 
tion, as  far  as  its  effect  on  long  time  investments  is  concerned, 
cannot  injure  the  interests  of  the  corporation,  the  public  or  the 
investor. 

As  the  several  forms  of  regulation,  except  that  of  cost-at- 
service  have  already  been  discussed  under,  the  "  Regulation-of- 
Security  Issues"  and  "Railroad  Regulation,"  let  us  examine 
this  form  of  control.  While  the  cost-at-service  form  of  regula- 
tion is  still  in  the  experimental  stage,  theoretically  at  least,  it 
would  seem  to  overcome  the  objections  of  the  fixed  fare,  which 
has  failed  so  ignominiously  in  the  last  ten  years.  According  to 
the  Federal  Electric  Railways  Commission,1  practically  all  of 
the  witnesses  before  this  commission  favored  the  service-at-cost 


^Report  of  the  Federal  Electric  Railways  Commission  to  the  Pres- 
ident, August,  1920  (Wash.  Gov.  Printing  Office),  p.  27. 


STREET  RAILWAY  BONDS  365 

franchises.  This,  of  course,  automatically  fixes  the  net  profits 
in  the  industry.  While  this  plan  also  has  the  objection  of  limit- 
ing the  stimulation  which  goes  with  the  reward  of  profits,  it  does 
have  the  inherent  possibility  of  stabilizing  the  industry.  There 
is  an  even  greater  objection  at  least  so  considered  by  some, 
namely,  the  determination  of  costs  and  the  possible  development 
of  inefficiency  and  uneconomical  operation.  But  these  difficul- 
ties are  not  impossible  of  solution.  Further,  as  rates  will  con- 
tinue to  be  regulated  and  the  investor  is  not  alone  the  only  one 
to  be  considered  in  any  regulatory  measures,  any  permanent 
adjustment  must  be  made  in  justice  to  all  parties.  This  seems 
to  be  the  most  reasonable  arrangement  that  has  so  far  been 
made  for  handling  street  railway  rates.  They  provide  fairly 
definite  terms  on  which  rates  can  be  increased  or  lowered. 
Investors  also  can  know  fairly  definitely  what  to  anticipate 
from  the  money  which  they  put  into  these  securities. 

Many  of  the  faults  in  regulation  from  which  the  utilities 
would  have  suffered  have  been  offset  in  their  remarkable  growth. 
But  when  the  growth  of  an  industry  slows  up  and  at  the  same 
time  costs  suddenly  mount  as  in  the  last  few  years,  the  faults 
which  may  exist  in  regulation  quickly  reveal  themselves.  While 
some  of  these  faults  in  regulation  have  long  been  known,  the 
franchises  of  public  utilities  have  never  before  been  put  to  a 
real  test.  On  the  other  hand,  it  must  be  admitted  that  with 
changing  conditions  in  industry,  new  forms  of  control  are 
needed,  but  this  can  only  answer  in  part  for  the  chaotic  financial 
condition  which  has  existed  in  the  past  five  years  in  the  public 
utility  industry,  especially  in  many  street  railways/ 

The  basis  of  rate  making  for  public  utilities  has  often  been 
so  uncertain,  and  the  machinery  for  rate  fixing  has  often  worked 
so  crudely,  that  they  have  had  a  material  effect  on  the  price  of 
a  considerable  number  of  public  utility  securities.  Any  change 
in  franchise  regulations,  which  would  tend  to  remove  these 
uncertainties,  should  be  of  the  utmost  value  to  investors  of 


'According  to  the  Report  of  the  Federal  Electric  Railways  Commis- 
sion (1920.  p.  7) ,  on  May  31.  1919,  there  were  02  companies  in  receiver- 
ship, and  by  July  1,  1920.  56  companies  were  added  to  the  list  and  98 
companies  had  either  abandoned  or  junked  a  part  of  their  mileage. 


366  INVESTMENT  ANALYSIS 

public  utility  securities.  The  unfortunate  experiences  of  the 
past  five  years,  as  previously  stated,  have  fully  awakened  the 
public  to  this  situation,  and  a  very  considerable  number  of 
street  railway  securities  will  be  transferred  from  the  specula- 
tive class  to  the  investment  class  in  the  next  few  years. 

Another  factor,  which  has  made  more  serious  inroads  into 
street  railway  revenues  than  the  general  public  has  realized,  is 
the  jitney.  This  has  been  particularly  true  of  street  railways  in 
moderate  sized  cities.  Of  this  competition,  the  Federal  Electric 
Railways  Commission  states:  "Jitney  competition  began  about 
1912,  and  was  at  first  entirely  unregulated.  Even  today,  in  some 
places  it  continues  with  no  regulation  of  any  kind,  and  in 
many  places  with  only  partial  and  inefficient  regulation.  In  no 
instance  has  this  so-called  jitney  carriage  of  passengers  been 
subjected  to  obligations  as  to  payment  of  taxes,  maintenance  of 
highways,  character  and  extent  of  service  and  financial  respon- 
sibility for  accidents  under  which  the  electric  railway  business 
is  being  conducted.  The  portion  of  the  street  paved  and  main- 
tained by  the  electric  railway,  and  in  winter  cleared  of  snow 
at  its  own  expense,  is  taken  advantage  of  by  the  jitney  competi- 
tor without  compensation,  either  to  the  company  or  the  mu- 
nicipality and  often  to  the  serious  injury  of  the  street  railway 
by  interfering  with  the  prompt  and  regular  movements  of  its 
cars.  .  .  .  That  street  railway  service  and  jitney  service  can 
not  permanently  exist  and  pay  their  own  way  in  competition 
with  each  other  under  any  ordinary  urban  conditions,  seems  to 
be  well  established  by  experience  and  by  the  conditions  inherent 
in  local  transportation  service,  but  the  belief  is  general  that  the 
motor  bus  may  properly  be  used  to  supplement  the  service  ren- 
dered by  the  street  cars."  Furthermore,  the  jitneys  largely 
confine  themselves  to  the  short-haul  traffic  which  makes  this 
competition  all  the  more  serious. 

Again  there  is  no  need  to  argue  the  necessity  of  a  close 
examination  into  the  regulation  as  well  as  the  possible  compe- 
tition of  the  jitney  bus.  In  certain  types  and  sizes  of  cities,  this 
competition  has  made  decided  inroads  into  the  earnings  of  street 


Report  of  the  Federal  Electric  Railways  Commission  (1920),  p.  19. 


STREET  RAILWAY  BONDS  367 

railways.  While  regulation  may  eventually  be  brought  about, 
the  investor  cannot  anticipate  possible  changes  of  this  character 
too  long  in  advance.  The  conservative  investor  must  be 
governed  more  largely  by  the  tested  experience  of  the  cor- 
poration. 

As  most  students  of  public  utility  regulation  now  agree, 
regulation  should  not  be  left  to  the  local  community  but  to  the 
state.  Local  prejudices  and  political  control  are  apt  to  exer- 
cise a  more  decided  influence  than  where  common  legislation 
exists  in  the  control  of  all  cities.  After  all,  the  fundamentals 
governing  rates,  capitalization,  valuation,  depreciation,  taxes, 
returns,  etc.,  should  be  the  same  for  all  cities.  Sufficient  elas- 
ticity can  be  allowed  in  details  of  operation,  services,  etc.,  to 
permit  adaptation  to  local  conditions.  While  this  discussion 
which  dovetails  into  the  discussion  on  Regulation  of  Security 
Issues  and  Railroad  Regulation  has  not  gone  into  minute  detail, 
it  is  sufficient  to  give  evidence  of  the  kind  of  problem  that  the 
investor  must  analyze  in  examining  street  railway  securities. 
But  despite  the  unsatisfactory  situation  of  the  traction  com- 
panies during  the  last  five  years,  the  future  seems  much  more 
hopeful  for  the  industry.  The  difficulties  have  been  realized 
and  both  the  public  and  public  utility  commissions  are  respond- 
ing to  these  needs.  Of  course,  it  must  also  be  remembered  that 
even  with  these  common  difficulties  of  many  of  the  street  rail- 
ways, there  are  systems  which  have  continued  in  a  strong 
position  during  these  years. 

General  Characteristics  of  Bonds. — Street  railway  bonds  are 
few  and  simple  in  characteristics  as  compared  with  railroad 
bonds.  They  usually  are  first  mortgages  with  a  few  collateral 
consolidated  and  refunding  issues,  though  the  latter  have  been 
increasing  in  recent  years.  Bonds  issued  by  holding  companies 
as  first  lien  issues  are  those  requiring  closest  scrutiny.  These 
issues  are  rarely  first  liens  except  upon  new  extensions,  and 
these  are  generally  but  a  small  portion  of  the  total  equity. 
Bond  issues  upon  such  security  may  be  ample,  but  there  are 
now  outstanding  a  number  of  such  issues  of  holding  companies 
whose  subsidiary  corporations  are  already  heavily  loaded  with 
bonds.  First  liens  of  such  corporations  have  little  significance. 


368  INVESTMENT  ANALYSIS 

Now  and  then  a  second  mortgage  appears  under  the  title  of  the 
last  three  issues.  . 

The  maturity  of  these  bonds  varies  between  twenty  and 
forty  years,  though  a  large  number  of  them  are  callable  after 
a  stipulated  period  at  a  premium  as  high  as  ten  points.  They 
are  more  often  subject  to  call  in  part  than  as  a  whole.  The 
nominal  rate  averages  from  51/2  to  7  per  cent.  As  few  of  the 
bonds  are  listed,  there  is  never  a  very  wide  market  for  the 
strictly  interurban  securities,  although  their  market  has  been 
increased  in  the  last  eight  years,  and  several  bonds  now  have 
a  national  market.  This  change  can  be  attributed  to  the 
strengthening  on  the  part  of  the  companies  themselves  and  the 
corrections  of  the  former  loose  financial  methods  brought  about 
by  conservative  investment  bankers.  A  number  of  these  prop- 
erties have,  as  a  result  of  these  changes,  become  very  desirable 
properties  and  their  securities  have  a  ready  market. 

Practically  all  of  the  older  issues  have  the  sinking  fund 
provision,  which  is  not  always  found  in  the  new  issues.  A 
number  of  the  large  recent  issues  are  provided  with  the  open- 
end  clause,  now  typical  among  a  large  number  of  public  utili- 
ties, which  allows  for  an  increase  of  funded  debt  to  the  total 
amount  of  60  to  85  per  cent  of  new  construction. 


CHAPTER  XX 
ELECTKIC  LIGHT  AND  POWER  BONDS 

Statistics  dealing  with  electric  lighting  and  power  companies 
cannot  be  treated  with  the  same  assurance  as  those  of  gas  and 
waterworks.  As  with  the  street  railway,  electric  lighting  and 
hydro-electric  power  development  came  so  rapidly  that  the  in- 
dustry seems  long  established  to  the  casual  observer. 

The  electric-light  was  demonstrated  by  Sir  Humphrey  Davy 
as  early  as  1808,  though  it  was  not  until  almost  1880  that  the 
incandescent  lamp  was  used  by  commercial  companies.  The 
period  from  1880  to  1890,  though  marked  by  a  considerable 
expansion,  experienced  a  number  of  unsuccessful  attempts  to 
establish  electric  lighting  corporations.  The  expensive  methods 
of  generation  still  made  the  cost  of  current  abnormally  high,  and 
this  high  cost,  together  with  the  uncertainties  attendant  upon 
a  new  business,  rendered  the  industry  unstable.  During  this 
era,  considerable  hostility  also  existed  between  the  arc  and  the 
incandescent  light  interests,  but  this  was  a  purely  prejudiced 
commercial  rivalry,  and  not  a  serious  technical  difficulty,1 
though  it  did  tend  to  handicap  the  business  in  localities  where 
price-cutting  resulted. 

The  most  significant  recent  development  in  the  electric  light- 
ing industry  has  been  the  increased  area  which  inventions, 
affecting  long  distant  transmissions,  have  enabled  the  central 
station  power  house  to  reach.2  With  a  large  power  plant  and 
trunk-wire  lines  built,  a  very  small  additional  expense  is  in- 
volved in  supplying  current  to  the  smallest  hamlet  within  a  very 
considerable  radius  of  the  hydro-electric  plant.  Wider  distribu- 
tion and  larger  centralization  bring  about  a  more  effective  use  of 


^Central  Electric  Light  and  Power  Stations,  1905,  p.  4  (Department 
of  Commerce  and  Labor  Bureau  of  Census,  United  States). 
2See  Hydro-Electric  Securities,  Chap.  xxii. 

369 


370  INVESTMENT  ANALYSIS 

the  generating  plant  and  thus  enable  the  company  to  sell  cur- 
rent at  such  prices  that  the  output  is  augmented. 

These  advantages  existing  in  the  control  of  large  plants,  have 
induced  syndicates  to  obtain  control  of  a  number  of  plants  in 
order  that  a  large  operating  unit  may  be  developed.  The  ad- 
vantages of  large  units  obtain,  especially  in  the  large  cities,  and 
consequently,  the  largest  percentage  of  syndicate  control  is  in 
urban  centers  and  their  adjoining  territory. 

A  compilation  made  by  the  Electric  World  in  1913,1  of 
central  stations  in  towns  and  cities  over  1000  in  population, 
shows  that  out  of  4774  plants,  "48  per  cent  of  the  total  num- 
ber of  central  stations  in  these  communities  are  independent  of 
financial  connections,  close  or  remote,  with  other  properties; 
that  29  per  cent  of  the  total  number  of  plants  are  held  under 
some  form  of  syndicate  or  generally  admitted  financial  control 
by  well-known  interests  and  that  23  per  cent  of  the  total  number 
of  plants  are  municipal.  .  .  .  We  find  that  in  the  cities  of  over 
100,000  population,  87%  of  the  plants  are  controlled  by  some 
form  of  syndicate,  holding  company,  or  financial  interest.  The 
proportion  is  slightly  smaller  in  cities  of  between  50,000  and 
100,000,  being  84  per  cent.  In  the  cities  of  still  smaller  size 
the  proportion  of  plants  owned  or  controlled  by  syndicates 
becomes  less.  In  the  cities  between  10,000  and  50,000  popula- 
tion 63  per  cent  of  the  plants  are  held  by  syndicates.  In  the 
cities  of  the  next  smaller  group,  5,000  to  10,000  population,  44 
per  cent  of  the  plants  are  held  by  syndicates.  The  proportion  is 
reduced  to  20  per  cent  in  the  cities  of  between  1000  and<  5000 
population."  Similarly,  the  proportion  of  the  municipal  plants 
to  the  total  number  of  plants  decreases  with  the  size  of  the  city. 
This  same  compilation  adds  concerning  this:  "The  proportion 
of  municipal  plants  is  but  3  per  cent  in  the  larger  cities."  It 


Electrical  World,  1913,  vol.  Ixii,  pp.  458  and  482.  The  data  for  this 
compilation  were  taken  from  McGraw's  Electrical  Directory,  and  Poor's 
and  Moody's  Manuals  of  Public  Utilities.  Though  the  figures  for  1912 
are  now  out  of  date,  they  are  the  only  available  national  data  which  we 
have.  These  percentages,  however,  have  not  changed  much  in  the  aggre- 
gate ;  consequently,  the  compilation  given  above  is  not  as  old  as  appears 
from  the  date  of  citation. 

See  also  estimated  figiires  for  1920  in  Electrical  World,  vol.  Ixvii 
(January  1,  1921),  pp.  39-46. 


ELECTRIC  LIGHT  BONDS  371 

should  also  be  borne  in  mind  that  the  larger  cities  furnish  both 
the  larger  gross  revenue  and  the  larger  net  profits,  because  of 
the  greater  density  of  population  and  the  advantage  of  lower 
costs  in  large  scale  production.  More  than  90  per  cent  of  the 
total  income  in  the  United  States  from  electric-light  stations  is 
from  central  commercial  stations. 

The  situation  of  electric-light  companies  which  Mr.  Martin 
summarized  in  19121  still  continues  at  the  present:  "The  vast 
majority  of  them  (i.e.  cities)  being  under  unified  control  but 
subject  to  the  regulation  of  public  service  commissions,  as  to 
their  rates,  capital,  conditions  of  service,  and  other  features  of 
work.  ...  In  the  case  of  the  Boston  Edison  Co.,  which  sup- 
plied electricity  originally  to  one-eighth  of  a  square  mile,  the 
area  embraced  by  the  circuits  of  the  same  company  is  now  700 
square  miles."  The  real  advantage  in  these  consolidations  has 
been  in  the  cheapened  costs.  This  report  states  further:  "The 
advantages  of  such  interconnected  operations  are  best  illus- 
trated by  the  example  of  the  Lake  County  district,  Illinois, 
where  this  unified  service  effected  a  decrease  in  production  costs 
from  7.07  cents  per  kilowatt  hour  to  2.87  cents  per  kilowatt 
hour,  a  saving  of  4.21  cents  per  unit."  The  following  sum- 
mary from  President  T.  E.  Murray's  paper  before  the  Edison 
Illuminating  Companies  in  September,  1911,  brings  out  the  im- 
portance of  low  costs  of  construction :  ' '  The  importance  of  striv- 
ing after  low  cost  of  construction  per  kilowatt3  of  station 
capacity  will  be  appreciated  when  it  is  considered  that  the  effect 
of  a  saving  in  station  investment  cost  of  $5  per  kilowatt  is 
equivalent  to  an  annual  saving  in  the  coal  of  12  per  cent  with 
coal  at  $3  per  ton  where  a  fixed  annual  charge  on  the  invest- 
ment of  14  per  cent  is  allowed  to  cover  interest  depreciation  and 
taxes."4 


Thomas  Commerford  Martin,  Part  II  Technical,  United  States  Cen- 
sus Bureau,  Central  Electric  Light  and  Power  Stations  and  Street  Rail- 
ways (1912),  p.  111. 

*Ibid.,  p.  112.  (These  prices  of  course  have  increased  since  this  re- 
port was  made.) 

*The  standard  unit  of  measurement  for  electric  current  is  the  kilo- 
watt hour,  "A  unit  of  work  or  energy  equal  to  that  done  by  one  kilo- 
watt acting  one  hour"  (approx.  —  1.34  horse  rower  hours). 

•Ibid.,  p.  114. 


372  INVESTMENT  ANALYSIS 

Population,  Physical  Factors,  and  Territory  Served. — The 
class  of  people  served,  their  geographical  distribution,  and  the 
number  and  size  of  the  industries  are,  as  with  other  public 
utilities,  the  first  considerations.  Any  irregularities  in  popula- 
tion distribution,  however,  will  not  be  as  serious  to  electric-light 
companies  as  with  either  traction  or  gas  companies,  for  the 
equipment  of  the  former  is  much  more  elastic  in  its  adaptation. 
Gas  mains  or  rails  are  expensive  to  install,  so  that  when  exten- 
sions are  made  the  growth  of  the  locality  must  be  anticipated 
for  a  number  of  years.  On  the  other  hand,  if  electric  lighting 
lines  are  to  be  placed  in  a  new  territory,  light  poles,  etc.,  can 
be  installed  and  these  poles  can  be  readily  replaced  at  a  rela- 
tively low  cost,  as  compared  with  the  laying  of  rails  or  gas 
mains.  Electric  lighting  companies  consequently  have  much 
greater  power  over  the  control  of  this  part  of  their  fixed  invest- 
ment, debarring  an  unreasonable  ordinance. 

Neither  does  the  character  of  topography  have  the  effect 
upon  the  cost  of  construction  which  it  has  upon  cost  of  laying 
mains  for  gas  companies  or  tracks  for  street  railways.  "With 
street  railways,  a  hilly  city  always  means  a  large  increase  in  the 
constant  cost  of  operation,  though  a  similar  condition  would 
have  no  effect  on  the  operation  cost  of  electric-light  companies. 
The  effect  of  location  upon  power  plants,  however,  is  para- 
mount. If  a  city  is  near  enough  to  water-power,  the  cost  of 
current  may  be  materially  lessened  or  current  may  be  purchased 
to  advantage  from  a  hydro-electric  company.  In  fuel-using 
power  plants,  the  location  near  a  coal  or  oil  field  or  waterway 
connection  with  a  coal  field  will  give  advantages  in  transporta- 
tion costs.  Though  the  problems  of  power  plant  costs  are  much 
the  same  as  those  of  other  public  utilities,  there  is  again  more 
adaptability  to  existing  needs  in  initial  construction  costs  of  the 
fuel-using  power  plants  than  in  water-power  plants. 

Density  of  population  has  a  direct  bearing  upon  the  earning 
power  of  electric  light  companies,  as  with  gas  companies.  ''In 
general,  the  larger  the  capital  invested  in  proportion  to  the 
annual  revenue,"  states  Mr.  Junkersfeld,  "the  more  important 
is  the  matter  of  density.  For  instance,  the  capital  invested  in 
many  public  utilities  is  turned  over  about  once  in  from  four 


ELECTRIC  LIGHT  BONDS  373 

to  six  years.  .  .  .  The  slower  the  turnover  the  most  important 
is  it  to  make  every  dollar  invested  serve  as  many  customers  as  , 
possible,  in  order  to  prevent  the  turnover  from  being  still 
slower."1  If  congestion  of  population  becomes  so  great  that 
the  company,  for  the  safety  of  the  public,  is  required  by  ordi- 
nance, to  lay  underground  wires,  the  cost  of  wiring  is  greatly 
increased. 

Without  a  technical  knowledge  of  electric-light  properties 
and  equipment,  an  appraisal  by  independent  engineers  at  cer- 
tain intervals  is  almost  essential  to  the  investor.  If  a  thorough 
appraisal  is  once  made,  it  is  of  course  not  so  essential  that  sub- 
sequent appraisals  be  as  complete.  The  rapid  depreciation  and 
especially  the  obsolescence  of  electric-light  equipment  require 
a  constant  and  close  check  upon  the  equipment  of  electrical 
properties.  For  the  general  investor  the  kilowatt  capacity  of 
the  dynamos  gives  a  more  significant  idea  of  the  plant  than  the 
more  detailed  enumeration  of  prime-movers,  boilers,  dynamos, 
etc.,  or  even  horse  power,  though  a  detail  of  plant  equipment 
should  be  had  for  an  accurate  check  on  depreciation.  To  the 
technician  other  engineering  devices  which  economize  in  the  use 
of  fuel,  character  of  lines,  poles,  transformers,  character  of 
street  lights,  etc.,  are  valuable,  though  the  financial  statistician 
secures  his  estimate  of  the  same  thing  in  operating  costs. 

Capital,  Capitalization,  and  Property  Accounts. — The  com- 
mercial stations,  as  stated,  represent  the  larger  share  of  capital 
with  more  than  95  per  cent  of  the  capital  investment  of  all  elec- 
tric lighting  stations.  In  the  commercial  organizations,  com- 
mon stock  represents  50  per  cent,  preferred,  approximately  10 
per  cent,  and  funded  debt,  40  per  cent  of  the  capitalization.  The 
amount  of  current  produced  per  dollar  of  investment,  however, 
has  increased  at  a  greater  rate  than  capitalization.  The  lower 
comparative  percentage  of  increase  in  earnings  for  the  industry 
as  a  whole  for  the  same  period  would  be  normal,  because  of  the 
lowering  of  electric  rates  and  the  very  great  increase  in  new 
and  permanent  construction  not  yet  utilized  for  future  needs 
in  the  next  ten  to  twenty-five  years.  "When  the  growth  of  popu- 

*Peter  Junkersfeld,  Address  before  tTie  Indiana,  Engineering  Society, 
Thirty-seventh  Convention,  January  18,  1917. 


374  INVESTMENT  ANALYSIS 

lation  has  reached  the  point  where  the  complete  utilization  of 
this  expenditure  is  realized,  income  should  show  an  even  larger 
ratio  of  increase  if  rates  are  not  radically  reduced  or  increased 
costs  do  not  outweigh  the  advantages  normally  accruing  from  a 
foresighted  policy  of  construction.  These  conditions  especially 
apply  where  the  power  is  furnished  by  hydro-electric  stations. 

To  insure  an  accurate  valuation,  as  stated  under  the  pre- 
vious topic,  an  engineer's  report  is  generally  required  because 
of  the  wide  differences  in  electric-light  accounting  systems.  A 
great  many  electric  lighting  companies  do  not  separate  land, 
buildings,  and  other  items  in  the  so-called  property  accounts. 
Whether  the  allowed  depreciation  is  what  it  should  be  can  be 
determined  only  from  a  complete  statement.  Neither  is  there 
any  common  method  of  handling  the  depreciation  account 
where  depreciation  is  allowed.  It  may  be  written  off  in 
operating  accounts  or  carried  as  a  depreciation  reserve  or 
directly  deducted  from  the  plant  accounts.  The  book  value 
of  property  accounts  may,  on  the  surface,  reflect  a  different 
condition  from  that  which  the  more  careful  analysis  will  reveal. 

A  distinction  between  station  plant  and  distribution  of  the 
company's  investments  is  useful  in  detecting  more  accurately 
the  weak  points  in  the  utilization  of  the  company's  fixed  invest- 
ment. A  badly  planned  distributing  system  which  the  com- 
pany has  acquired  and  not  had  time  to  rehabilitate  may  prove 
a  heavy  burden.  No  arbitrary  ratio  between  the  porportion  of 
these  investments  can  be  given.1  The  reports  of  the  Massa- 
chusetts Board  of  Gas  and  Electric  Light  Commissioners,  which 
are  the  most  complete  and  detailed,  give  a  fair  criterion  of  the 
property  and  capitalization  of  electric  lighting  corporations  in 


'"The  distribution  of  the  cost  of  a  fair-sized  station  per  kilowatt 
(T.  E.  Murray,  Association  of  Edison  Illuminating  Companies,  Sep- 
tember, 1911)  : 

Per  Cent 

Total   100 

Building  structure 30 

Boilers,  furnaces  and  auxiliaries 20 

Turbines,  generators,  condensors  with  auxiliaries....       25 

Piping  systems 10 

Switchboards  and  other  electrical  work 7 

Miscellaneous  small  items,  etc 8 


ELECTRIC  LIGHT  BONDS  375 

this  state.  The  table  given  below  is  a  summarization  by  Mr. 
Lincoln,  in  which  he  has  made  certain  pertinent  summaries.1 

The  relation  of  the  connected  load  and  the  peak  load  costs  to 
property  investment,  discussed  under  a  subsequent  topic,  reveals 
the  effective  use  of  the  investment  of  the  property  and  should 
be  required  in  any  analysis  of  electric  lighting  securities.  An 
increasing  connected  load  and  its  proper  distribution  in  rela- 
tion to  the  amount  of  investment  in  plant  and  equipment  should 
always  result  in  increased  earnings.  While  unused  capacity 
must  always  exist  in  the  average  plant  in  economically  prepar- 
ing for  future  growth,  the  examiner  must  ascertain  whether 
this  anticipation  has  been  over-reached  in  too  high  a  carrying 
charge  in  present  investments.  This  danger  is  especially  likely 
to  exist  where  hydro-electric  power  plants  are  constructed. 

As  directly  related  to  the  growth  of  the  community,  the 
connected  load  can  be  studied  with  profit  as  to  the  future  effects 
upon  earnings.  Furthermore,  it  is  important  to  know  whether 
the  investment  per  capita  and  per  consumer  of  the  company  has 
been  decreasing,  though  the  total  amount  is  increasing.  This 
eventually  results  in  a  retarding  increasing  return ;  i.  e.,  the 
saturation  point  has  been  reached.  This  information  is  par- 
ticularly important  if  the  company's  policy  is  to  make  or  if  it 
is  likely  to  be  ordered  by  some  commission  to  make,  extensive 


delations  between  Investment  and  Extent  of  Business  for  1915 

(Massachusetts) 
(Average  per  Plant) 

Municipal  Private 

Average  per  Plant                                             Owned  Companies 

Total  Investment   $171,990  $  310,840 

Station  Investment   97,138  150,999 

Distribution  Investment 74,852  159,841 

Kilowatt  Capacity   951  1,366 

Average  K.  W.  per  Dynamo  269  314 

Current  delivered  (K.  W.  H.)    881,914  1,437,544 

Length  of  streets  with  overhead  (miles) 41.1  55.9 

Length  of  all  lines  (miles)   174  256.1 

Length  on  conduits  (miles)    21.1 

Length  of  cables  in  conduits  (miles) 123.3 

Number  of  street  lamps  673  677 

Number  of  poles 1,355  2,655 

Number  of  customers 1,063  1,377 

Age  of  station  units  (years)   9.1  7.6 

(Edmund  Earle  Lincoln.  The  Results  of  Municipal  Electric  Lighting 
in  Massachusetts  [1918],  p.  160.) 


376  INVESTMENT  ANALYSIS 

improvements.  A  company's  position  is  not  necessarily  endan- 
gered by  retarding  increasing  returns,  though,  as  previously 
emphasized,  this  point  should  not  be  overlooked  in  estimating 
future  growth.  Eegardless  of  whether  the  decreasing  return 
per  capita  is  the  result  of  a  lowering  of  rates  or  the  increase 
of  smaller  consumers  or  an  increased  utilization  of  Tungsten 
lights,  which  require  less  current,  the  effect  upon  earnings  is 
the  same,  though  a  large  growth  of  industrial  corporations 
demanding  current  would  again  alter  these  conditions.  Whether 
a  permanent  or  a  temporary  saturation  point  has  been  reached, 
must  be  concluded  from  a  detailed  study  of  the  character  of 
the  community. 

The  per  capita  measurement  referred  to  in  this  discussion 
as  an  isolated  unit  of  comparison  is  entirely  misleading.  For 
illustration,  a  corporation  with  a  low  property  investment  and  a 
high  operating  ratio  could  not  as  a  rule  carry  as  high  a  fixed 
charge  as  a  company  with  a  larger  property  account  and  low 
operating  ratio.  The  unit  can  be  used  only  as  a  relative  unit 
of  measurement.  Also  variation  in  rates,  changes  in  valuation, 
difference  in  taxes,  difference  in  the  distribution  of  capitaliza- 
tion, individually  or  together,  can  make  such  decided  difference 
in  the  relative  importance  of  fixed  property  accounts  that  the 
results  of  any  single  comparative  unit  standard  of  fixed  invest- 
ment are  without  any  serious  consequence. 

The  control  and  development  of  basic  patents  in  the  gen- 
eration and  distribution  of  electric  current  heat  and  power  have 
often  created  a  unique  position  for  electric-light  holding  com- 
panies. The  method  generally  followed  by  a  company  control- 
ling the  patents  is  to  manufacture  these  appliances  and  rent 
them  or  license  the  local  operating  company  to  use  them.  In 
the  early  development  of  this  control,  the  parent  company  was 
compensated  by  securities  of  the  operating  company  for  all  or  a 
portion  of  its  supply  of  patent  equipment  and  devices.  The 
most  common  method  of  control  has  been  for  the  controlling 
companies  to  require  the  purchase  of  at  least  a  certain  portion 
of  the  equipment  from  the  parent  company  at  stipulated  prices. 
A  frequent  practice  which  grew  out  of  this  was  to  capitalize  these 
patents  and  rights,  a  procedure  which  often  led  to  inflation 


ELECTKIC  LIGHT  BONDS  377 

of  the  asset  accounts.  A  later  development  has  been  the  out- 
right purchase  by  holding  companies.  An  intermediary  financ- 
ing company  controlled  by  the  large  equipment  companies  is 
now  also  used  in  providing  loans  to  operating  companies  which 
agree  to  purchase  from  the  equipment  company. 

The  greatest  development,  however,  has  been  in  the  large 
holding  organizations  such  as  Stone  and  Webster,  White  and 
Byllsby.  These  companies  buy  up  all  types  of  public  utilities 
and  control  every  aspect  of  the  industry.  In  this  centralization 
of  the  financing,  the  purchasing  of  material  and  the  operating 
of  plants  the  greatest  efficiency  is  secured. 

Depreciation. — A  common  fault  in  the  earlier  years  of  elec- 
tric lighting  companies  was  the  failure  to  recognize  depreciation. 
No  well  managed  company  today  follows  this  haphazard  method 
of  operation.  Some  companies  still  maintain  that  they  are  in- 
cluding their  depreciation  in  their  current  repair  accounts  and 
make  no  separate  provision  for  it.  The  maintenance  accounts 
should  then  show  a  higher  than  the  normal  average.  Seldom  is 
this  true  of  the  companies  which  make  this  claim.  It  prac- 
tically always  discloses  the  general  lack  of  exactness  in  the  ad- 
ministrative policy  of  the  company. 

The  specific  amount  must  vary  somewhat  with  the  locality 
and  the  conditions  under  which  the  company  operates.  A  com- 
pany with  a  hydro-electric  power  plant  should  have  a  lower 
amount  than  the  company  which  is  entirely  dependent  upon  the 
generating  of  current  by  fuel  process.  Massachusetts  requires 
a  3  per  cent  rate  for  all  of  its  municipal  plants.1  Generally, 
however,  state  commissions  have  offered  so  many  loose  decisions 
that  their  allowances  must  be  checked  with  caution. 

Mr.  H.  M.  Edwards  of  the  New  York  Edison  Company  states 
concerning  the  experience  of  his  company: 

"A  percentage  of  the  book  value  of  the  property  did  not 
include  the  element  of  work  done,  and  a  percentage  of  the  gross 
earnings  did  not  bear  equally  on  the  product  because  of  the 
rate  schedules.  Upon  the  latter  basis,  assuming  that  the  reserve 
was  to  be  10  per  cent  of  the  gross  earnings  derived  from  the 
sale  of  electric  current;  the  price  to  the  retail  customer  would 


'Massachusetts  statutes,  1908,  chap.  486. 


378  INVESTMENT  ANALYSIS 

be  10  cents  per  kilowatt  hour;  although  the  depreciation  effect 
of  both  sales  might  be  the  same.  The  plan  of  creating  a  reserve 
by  an  appropriation  from  surplus  earnings  was  disregarded, 
the  reasons  of  which  will  be  set  forth  later,  and  the  company 
finally  adopted  as  its  plan  a  rate  of  Ic  per  kilowatt  hour  sold 
to  its  general  customers.  .  .  . 

"Summing  up  all  the  points  of  the  discussion,  the  following 
recommendations  would  seem  justified: 

"First, — in  view  of  the  fact  that  depreciation  in  electric 
light  plants  is  to  be  an  extraordinary  extent,  the  result  of  super- 
session rather  than  of  wear  and  tear,  the  reserve  should  be 
determined  by  the  general  rather  than  the  special  method. 

"Second, — considering  the  nature  of  the  business,  and  be- 
cause of  the  fact  that  the  entire  product  consists  of  electric 
energy  expressed  in  kilowatt  hours,  the  most  feasible  way  of 
determining  the  amount  of  the  reserve  is  by  a  rate  per  kilowatt 
hour  generated  sold,  according  as  local  conditions  apply. 

"Third, — in  view  of  the  fact  that  depreciation  is  a  definite 
item  in  the  cost  of  operation,  the  reserve  should  be  built  up 
through  operating  expense  and  not  as  an  appropriation  from 
surplus. 

"Fourth  and  finally, — any  member  company  which  has  not 
yet  provided  for  depreciation,  should  do  so  at  once,  otherwise 
the  day  of  reckoning  will  soon  arrive  and  delay  may  seriously 
affect  its  financial  stability." 

Earnings. — The  proportion  of  net  earnings  to  capitalization 
measures  the  returns  on  capital  funds,  but  the  character  of  the 
load  factor,  the  output  per  capita,  and  the  income  per  kilowatt 
hour  determine  the  efficiency  in  operation.  While  the  low 
operating  costs  experienced  by  some  companies  can  never  be 
obtained  by  other  companies,  because  of  the  character  of  terri- 
tory, population,  and  the  consequent  lower  diversity  and  higher 
peak  loads,  the  comparative  results  under  similar  external  con- 
ditions are  the  best  indicator  of  the  character  of  the  efficiency 
in  management  and  what  may  be  expected  from  the  company. 


'The  author  has  reference  here  in  his  statement  to  the  general 
method  of  the  New  York  Public  Service  Commission  Plan  of  treating  the 
subject  of  depreciation  as  one  item,  the  reserve  accumulation  being  avail- 
able for  any  replacements. 

H.  M.  Edwards.  Natural  EJectric  Lifjht  Association.  Thirtv-fourth 
Convention.  New  York  City,  May  29.  1911.  vol.  ii.  pp.  180-186.  See  also 
recommendations  of  National  Electric  Lifjht  Association,  37th  Conven- 
tion, Accounting  Session,  Jun'?,  1914,  pp.  197-198. 


ELECTRIC  LIGHT  BONDS 


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380  INVESTMENT  ANALYSIS 

Net  earnings,  at  least  temporarily,  may  be  made  to  look  favor- 
able by  the  sacrifice  of  depreciation,  maintenance,  or  better- 
ments; but  the  relationships  per  capita,  output,  load  factor, 
and  income  per  kilowatt  hour  cannot  be  whitewashed.  The  sta- 
tisticians of  the  Commonwealth  Edison  Company  of  Chicago 
have  given  us  some  illuminating  data  upon  this  side  of  electri- 
cal operation.  In  the  examination  of  a  particular  group  of 
cities  as  well  as  the  general  data  of  the  United  States  Census 
it  was  found  that  as  the  output  per  capita  increased,  the  load 
factors  were  better  distributed  and  both  the  income  and  cost 
per  kilowatt  hour  decreased.  Niagara  Falls,  for  illustration, 
which  had  the  largest  output  per  capita,  had  the  lowest  income 
per  kilowatt  per  hour.  The  data,  compiled  by  Mr.  Samuel 
Insull  of  the  Commonwealth  Edison  of  Chicago,  shows  that  the 
states  in  the  great  water  power  areas,  with  the  exception  of 
Chicago,  have  a  lower  income  per  kilowatt  hour,  a  high  output 
per  capita,  and  a  more  desirable  load  factor  than  cities  having 
artificial  power-plants. 

Electric-light  earnings,  as  is  the  case  with  all  public  utili- 
ties, have  the  very  desirable  feature  of  stability,  whether  the 
company  is  weak  or  strong.  Consequently,  if  potential  earn- 
ings can  be  absolutely  assured,  the  fixity  of  earnings  can 
always  be  determined  writh  considerable  accuracy.  As  would 
be  expected,  in  the  early  development  of  the  industry  consid- 
erable abuse  was  made  of  this  knowledge  and  impossible  future 
earnings  were  promised  in  order  to  assure  a  more  ready  and 
higher  market  for  securities  offered.  While  some  companies, 
under  the  conditions  of  abnormal  growth  luckily  falling  to 
them,  have  adjusted  their  finances  to  a  strong  basis,  a  large 
number  of  the  original  participants  in  these  questionable  prac- 
tices are  still  leveling  down  the  average  earnings  of  the  industry 
to  a  low  mark. 

To  procure  the  most  comprehensive  interpretation  of  the 
respective  value  of  the  important  items  in  the  income  state- 
ment, the  unit  costs  of  producing  electric  current  should  be  pro- 
rated to  each  one  dollar  of  income  namely:  (1)  the  operating 
cost  per  dollar  of  income;  (2)  the  interest  charges  per  dollar  of 
income;  (3)  the  depreciation  per  dollar  of  income;  (4)  the 
earnings  per  dollar  of  income;  (5)  the  income  per  kilowatt; 


ELECTKIC  LIGHT  BONDS  381 

(6)  the  total  cost  of  a  kilowatt;  (7)  the  total  cost  of  kilowatts 
sold;  and,  lastly,  (8)  the  ratio  of  earnings  and  new  capital  used 
in  the  expenditure  for  betterments. 

Costs  and  Peak  Load. — Any  one  who  even  superficially  in- 
vestigates the  technical  side  of  electrical  lighting  production 
discovers  that  the  output  in  small  plants  exclusively  devoted 
to  lighting,  suddenly  rises  from  six  to  eight-thirty  P.  M.  and 
then  almost  as  suddenly  disappears.  This  maximum  point  is 
termed  by  electrical  engineers  the  peak  load,  and  one  who 
studies  the  relationship  of  this  peak  load  to  costs  is  convinced 
that  its  control  determines  the  success  of  the  company.  It  is 
the  constant  burden  of  the  electrical  engineer  to  secure  an 
increasing  distribution  of  electrical  currents  throughout  the  day 
in  order  to  level  down  this  high  peak  load ;  i.  e.,  to  increase  the 
efficiency  of  the  producing  agents  of  water  power  or  steam. 

A  simple  but  very  effective  analysis  by  Halford  Erickson 
of  an  electric-light  plant  in  the  experience  of  the  Wisconsin 
Commission  illustrates  the  influence  of  diversity  in  loads  upon 
the  reduction  of  costs : 

"To  this  end,"  states  this  authority,  "I  will  assume  a  plant 
that  has  a  capacity  of  300  kilowatts;  that  has  an  average  daily 
use  of  the  current  of  about  five  hours;  that  has  an  operating 
expense,  including  taxes  and  interest  on  the  investment,  to  the 
amount  of  about  $18,000  for  the  year,  of  which  amount  two- 
thirds  is  covered  by  the  fixed,  and  about  one-third  by  the  vari- 
able expenses ;  and  that  has  a  connected  load  and  an  instantane- 
ous maximum  demand  that  about  equals  the  capacity  of  the 
plant.  .  .  . 

"As  the  total  fixed  expense  remains  the  same,  regardless  of 
output,  and  as  the  output  in  kw.  hrs.  increases  with  the  increase 
in  the  number  of  hours  of  daily  operation,  it  must  also  follow 
that  the  fixed  cost  per  kw.  hr.  decreases  with  increases  in  the 
output.  .  .  . 

"In  other  words,  the  variable  expenses  are  increasing  with 
increases  in  the  output  and  not  far  from  the  same  proportion. 

' '  Since  the  total  variable  expenses  thus  vary  with  the  output 
or  with  the  hours  of  daily  use  of  current,  it  must  also  follow 
that  the  variable  expense  per  kw.  hr.  is  about  the  same  when 
the  plant  is  used  one  hour  each  day  as  when  used  three  or 
more  hours  daily.  .  .  . 

' '  A  man  having  an  installation  and  demand  of  two  kilowatts 
and  using  his  current  only  one  hour  per  day,  consumes  no  more 


382  INVESTMENT  ANALYSIS 

current  than  a  man  having  an  installation  and  demand  of  one 
kilowatt,  but  who  is  using  his  current  two  hours  daily,  yet  the 
investment  for  the  former  must  be  twice  as  great  as  that  for 
the  latter.  Under  each  circumstance  it  is  manifestly  clear  that 
the  same  rate  per  kw.  hr.  for  both  cannot  be  a  just  or  fair 
rate.  .  .  . 

"These  decreases  in  the  cost  per  unit  which  follow  increases 
in  the  sales  indicate  how  extensions  in  the  business  may  become 
beneficial  to  both  the  operator  of  public  utilities  and  to  the  con- 
sumers of  their  services  or  products.  If  the  sales  are  extended 
without  any  reduction  in  the  rates  charged,  then  the  utility 
alone  would  be  benefited  by  the  reductions  in  the  cost.  If  on 
the  other  hand,  the  rates  are  reduced  proportionately  to  the 
increase  in  the  sales,  then  the  consumers  alone  would  be  benefited 
by  the  reductions  in  the  cost.  If  again,  the  rates  are  reduced 
to  the  extent  of,  say,  50  per  cent  of  the  reductions  in  the  cost, 
that  is  caused  by  the  larger  sales,  then  both  the  utility  and  the 
consumers  would  be  benefited  by  the  extension  of  the  business. 
Increase  in  the  sales,  or  extension  of  the  business,  may  then  be 
made  the  means  through  which  both  lower  rates  to  the  con- 
sumers and  greater  profits  to  the  plant  may  be  brought  about. 
These  facts  are  exceedingly  important  and  should  be  given  most 
serious  attention  by  all  who  are  connected  with  the  manage- 
ment of  public  utilities."1 

A  verification  of  the  same  principles  is  also  made  on  the 
experience  of  a  particular  plant  in  which  a  close  study  has  been 
made  of  this  problem.  Mr.  H.  P.  Gear  says  of  the  Chicago 
company's  experience: 

"The  cost  of  electric  service  is  made  up  of  factors  which 
are  proportional  to  the  capital  employed,  other  items  due  to 
the  generation  and  conversion  of  the  energy  which  are  propor- 
tional to  the  mileage  of  lines  in  service,  and  commercial  ex- 
pense which  is  proportional  to  the  number  of  customers  served 
and  to  the  volume  of  business  done." 

Variables  exist,  for  example,  according  to  the  distribution 
and  the  remoteness  of  the  population,  and  the  ratio  of  the 
population  that  are  consumers.  But  the  remoteness  of  a  point 


'Halford  Erickson,  Rates  for  Electric  Current,  in  the  pamphlet  on 
Regulation  of  Public  Utilities  (Madison,  Wis.,  Democratic  Printing  Co., 
1911),  pp.  13,  14.  15. 

JH.  P.  Gear,  The  Distribution  System  and  the  Cost  of  Electric  Serv- 
ice. Prize  Paper  in  National  Electric  Light  Association  Proceedings  of 
Thirty-seventh  Convention,  June  1-5,  1914,  p.  683. 

Mr.  E.  E.  Lincoln  (The  Results  of  Municipal  Electric  Lighting  in 
Massachusetts)  states  concerning  the  size  of  the  company  and  cost  of 
production  in  Massachusetts:  "If  one  extreme  case  of  Buzzard's  Bay 


ELECTRIC  LIGHT  BONDS  383 

does  not  increase  the  cost  at  the  same  ratio.  Density  of  the 
load,  on  the  other  hand,  is  a  far  greater  influence  on  the  cost 
of  service  than  remoteness  from  the  central  station.  When  a 
larger  system  of  trunk-lines  is  established,  the  additional  cost 
of  adding  new  users  is  very  small.1 


were  left  out,  the  curve  would  be  markedly  lower  for  the  companies 
generating  less  than  1,000,000  hours  than  for  the  corresponding  mu- 
nicipal plants.  For  plants  with  an  output  between  1,000,000  and  2,500,000 
hours  there  seems  to  be  little  evidence  of  decreasing  costs  because  of 
increasing  size  in  either  group.  This  tendency  is  most  marked  for  plants 
having  500.000  kilowatt  output,  although  it  is  plainly  to  be  seen  till  the 
1,000,000  size  is  reached."  (p.  184.) 

Samuel  Insull  in  an  address  before  Finance  Forum,  West  Side  Y.  M. 
C.  A.,  New  York  City,  Apr.  20,  1914  (published  in  pamphlet  form  by 
Russel  Brewster  &  Co.,  Chicago,  p.  17)  stated: 

"The  average  for  all  customers  is  30  per  cent  for  production  costs, 
14  per  cent  for  substation  ;  25  per  cent  for  transmission  and  distribution  ; 
12  per  cent  for  metering,  billing  and  collecting ;  and  19  per  cent  for 
general  expense.  These  percentages  include  both  investment  and  operat- 
ing expenses.  Further,  the  Chicago  statistics  show  that  the  average  user 
whose  annual  load  factor  is  32  per  cent  or  whose  average  use  of  electric 
current  is  seven  and  one-half  hours  a  day,  that  out  of  this  30  per  cent 
production,  charges,  that  16  per  cent  is  due  to  investments.  14  per  cent 
to  operation  and  distribution  and  6  per  cent  out  of  25  per  cent  is  due  to 
operation,  or  the  total  investment  charge  aggregates  52  per  cent  and  the 
operating  charge  48  per  cent  of  the  total.  If  the  load  is  less  than  32 
per  cent,  the  investment  charges  are  higher  and  the  operation  is  lower. 
The  cost  of  a  daily  two  hour  user  in  Chicago  is  about  three  times  the 
cost  of  the  average  user  and  the  twenty-four  hour  user  about  40  per  cent 
of  the  average  user,  though  the  decrease  of  the  operating  per  cent  is  not 
as  rapid  in  increased  hours  as  the  ratio  of  fixed  charges.  Verification  of 
this  principle  is  amplified  by  the  experience  of  the  relation  of  operation 
and  investment  of  a  large  number  of  small  plants,  i.  e.,  a  very  decided 
tendency  in  the  majority  of  plants  is  manifest." 

*Asrain  the  average  proportions  of  the  income  items  of  revenue  and 
expenses  compiled  by  Mr.  Lincoln  are  interesting.  (The  following  fig- 
ures are  a  few  selected  ones  taken  from  more  complete  tables.  The 
student  will  find  Mr.  Lincoln's  work  on  Massachusetts  electric  light 
plants  worth  careful  study  [p.  183].  The  Massachusetts  State  reports 
are  much  more  complete  than  those  of  any  other  state  and  offer  the 
most  comprehensive  data  for  intensive  study)  : 

Operating  Expense  per  K.  W.  Delivered  : 

Private          Municipal 
Companies       Owned  Co. 

Total  Expense   3.572c  3.766c 

Taxes    0.428c  

Salaries    '. 0.197e  

Total — taxes  deducted   3.144c  3.76oc 

Total — taxes  and  salaries  deducted 2.947c  3.766c 

Cost  of  Distribution    0.648c  0.782c 

Cost  of  Manuf.  (per  K.  W.  H.  made) 1.376c  1.829c 

Labor  at  Station  (per  K.  W.  H.  made) 0.408c  0.626c 

Fuel   (all  kinds)    (per  K.  W.  H.  made) 0.808c  0.915c 

Coal   (per  K.  W.  H.  made)    0.742c  0.933c 

Relation  between  Investment,  Depreciation  and  Repairs  (p.  220). 


384  INVESTMENT  ANALYSIS 

Rates.1 — From  the  peculiar  conditions  determining  the  cost 
of  electrical  current,  it  is  apparent  that  rate  schedules  which 
are  based  on  any  other  consideration  than  the  cost  of  service 
will  both  be  unjust  to  the  consumer  and  check  the  development 
of  the  business.  Where  the  security  of  the  issue  seems  amply 
protected  and  interest  charges  are  sufficiently  covered,  the  in- 
clination, even  of  many  underwriters  in  the  past  has  been  to 
pay  no  heed  to  the  subject  of  rates.  This  is  no  longer  true. 
Underwriters  of  electrical  securities  are  now  forced  to  give  it 
the  most  careful  attention. 

As  has  been  pointed  out,  the  cost  of  electricity  is  made  up 
of  two  classes  of  expenses;  namely,  variable  and  fixed.  The 
former  is  governed  by  the  amount  of  the  current  sold  and  the 
latter  by  the  maximum  demand.  Thus,  if  the  consumer  desired 
to  use  current  for  a  greater  number  of  hours,  this  would  in- 
crease the  output  without  demanding  an  increased  capacity  of 
the  plant.  The  fixed  investment  would  not  have  to  be  increased 
and  thus  the  company  would  be  affected  only  by  the  variable 
expenses.  On  the  other  hand,  if  the  maximum  demand  increases 
at  a  faster  rate  than  the  increase  in  output,  the  costs  usually 
increase,  as  the  fixed  expenses  are  the  greatest,  though  these 
conditions  vary  with  the  factors  affecting  the  operation  of 
every  plant. 

The  injustice  of  the  flat  rate  as  against  the  equity  of  the  rate 
built  on  approximate  cost  is  apparent.  For  illustration,  if  the 
flat  rate  were  used,  a  man  would  be  charged  the  same  price 
for  2,000  kilowatts  whether  used  in  one  hour  or  ten  hours, 
though  in  the  former  case,  there  is  demand  for  twenty  times  as 
much  plant  capacity,  i.  e.,  fixed  investment.  If  the  output 


(Only  the  average  of  1910  to  1915  is  given.) 

Investment  in  Plant  Depreciation  Repairs  Per  cent 

in  1915  Per  Cent  to  Investment    to  Investment 

Municipal  Cos $2,923.825  3.0%  3.1% 

Private   Cos 5,284.275  3.2%  2A% 

(Both  the  depreciation  and  repair  accounts  for  private  companies  show 
a  steady  decrease  for  the  period,  though  the  investments  in  plants  of 
the  companies  doubled,  while  municipal  owned  plants  increased 
slightly  over  one-half  million.) 

United  States  Census  Electrical  Industries  (Chapter  on  Technical 
Aspects  of  the  Industry),  gives  in  detail  the  rates  which  are  allowed  in 
the  respective  states. 


ELECTRIC  LIGHT  BONDS  385 

increases  with  the  diversity  of  the  load,  a  lowering  of  the  rate 
will  not  be  as  serious  a  menace  as  when  the  rate  is  lowered  and 
the  company  does  not  possess  this  advantage. 

Thus,  while  the  increasing  and  lowering  of  rates  will  always 
have  an  effect  upon  the  investment  status  of  the  investor's  hold- 
ings in  electric  light  plants,  a  very  wide  degree  of  difference 
will  result.  And  as  soon  as  investors  have  awakened  to  the 
full  significance  of  these  influences,  Public  Utility  Commissions 
will  be  forced  to  temper  their  decisions  in  a  greater  effort  to 
protect  the  investment  holdings. 

Some  General  Characteristics  of  the  Franchise. — It  seems 
only  necessary  to  indicate  the  features  in  the  franchise  which 
are  peculiar  to  the  manufacture  and  distribution  of  electricity. 
The  danger  from  the  overhead  wiring,  still  comprising  the 
major  part  of  the  wiring  for  electric  lighting  companies,  was 
recognized,  and  specific  regulation  placed  in  the  franchise  to 
minimize  these  dangers.  "While  the  danger  to  life  is  minimized 
in  the  use  of  underground  conduits,  the  losses  from  electrolysis 
have  forced  the  adoption  of  other  safeguards  which  are  an  addi- 
tional expense.  In  addition  to  these  extra  maintenance  charges, 
what  additional  construction  and  maintenance  charges  can  the 
city  require  in  the  future?  For  example,  a  company  which 
now  has  cheap  overhead  construction  may  eventually  be  forced 
to  replace  it  by  underground  conduits  which  may  result  in  a 
large  increase  in  costs.  This  would  be  especially  true  of  the 
smaller  sized  companies.  Damages  to  person  and  property 
might  also  become  too  heavy  a  charge  to  a  small  company. 

A  large  enough  plant  must  be  maintained  to  provide  for  the 
peak  load  of  the  day,  which  may  exist  for  only  two  or  three 
hours  at  the  most.  During  the  other  twenty-one  hours,  the 
greater  part  of  the  plant  is  shut  down.  The  failure  on  the 
part  of  the  public  to  appreciate  this  problem  of  fixed  invest- 
ment in  idle  property  to  supply  its  needs  for  a  very  short 
period  of  the  day  is  often  responsible  for  unreasonable  de- 
ma'nds.  And  an  understanding  of  this  peculiar  situation  in 
these  companies  would  often  prevent  unreasoning  opposition  to 
justified  rate  increases.  The  problem  is  further  complicated  by 
the  granting  of  special  rates  for  particular  purposes.  When  a 


386  INVESTMENT  ANALYSIS 

trolley  system  is  furnished  with  current,  the  curve  of  the  peak 
load  is  even  higher  and  more  abrupt,  as  the  rush  hours  occur 
at  about  the  same  time  as  the  heaviest  lighting  requirements. 

With  the  development  of  water-power  and  the  long  distance 
transmission  of  electrical  current,  the  industry  is  at  times  sub- 
ject to  inter-state  regulations.  And  with  the  interurban  com- 
panies, the  difficulties  and  differences  in  dealing  with  several 
municipalities  increase  the  problems  of  the  management.  With 
the  greater  appreciation  of  the  monopolistic  character  of  the 
industry,  the  danger  from  varying  expirations  of  charters  is  not 
fraught  with  the  dangers  of  cancellation  of  these  charters  that 
existed  twenty  years  ago.  Yet  it  is  much  better  that  no  impor- 
tant charter  expire  before  the  bond  issue.  The  greatest  diffi- 
culty is  the  tampering  with  the  existing  practices  and  rights 
of  the  charter  where  a  number  of  cities  are  served.  Here  again 
the  broader  power  of  the  Public  Service  Commission  has  pre- 
vented many  of  these  handicaps  which  would  otherwise  have 
come  to  the  front. 

Companies  now  having  franchise  rights  in  the  city  are  sel- 
dom endangered  by  the  competition  of  several  other  companies 
after  they  have  constructed  plants  and  equipment  for  the  ex- 
panding demand  of  several  years.  There  is  scarcely  a  city  in 
the  United  States  which  has  not  granted  several  companies 
franchises  to  furnish  electric  lighting.  When  the  Chicago  City 
Council  granted  the  present  charter  to  the  Commonwealth  Edi- 
son Company,  May  23,  1908,  twenty-five  franchises,  owned  or 
controlled  by  as  many  former  companies,  were  included  in  the 
ordinance.  The  National  Civic  Federation  claimed  to  have 
found  forty-seven  electric  light  franchises  which  were  granted  by 
the  city,  and  according  to  this  report  it  did  not  complete  the 
examination  of  all  of  the  city's  records.1  In  the  consolidation 
with  other  public  utilities  this  same  condition  may  exist,  though 
not  nearly  to  the  same  extent  as  with  the  consolidation  of  elec- 
tric light  companies  themselves.  It  is  consequently  needless  to 
emphasize  the  relationship  of  the  bond  issue  to  the  duration, 
rights,  and  powers  of  the  franchise. 


Rational  Civic  Federation,  Report  on  Municipal  and  Private  Opera- 
tion of  Public  Utilities,  Part  II,  vol.  i,  p.  719. 


ELECTRIC  LIGHT  BONDS  387 

The  Market  for  Electrical  Securities. — Despite  the  phenom- 
enal growth  of  the  industry,  public  utility  securities  have  not 
been  purchased  by  a  very  large  group  of  individual  investors. 
As  late  as  1913,  Mr.  Frank  A.  Vanderlip  made  the  statement 
that  not  over  twenty  per  cent  of  the  individual  investors  have 
bought  electrical  securities.1  This  twenty  per  cent,  however, 
included  the  majority  of  the  large  individual  and  institutional 
buyers.  Institutional  buyers  have,  ever  since  the  organization 
of  the  electric  lighting  industry,  furnished  the  largest  market 
for  these  bonds.  The  greater  part  of  the  common  stock  has 
always  been  and  continues  to  be  largely  held  by  small  groups 
of  controlling  interests.  But  the  market,  since  1905,  has 
been  developing  at  an  increasing  rate.  This  has  resulted  from 
the  education  of  the  public  concerning  the  opportunity  offered 
in  these  securities,  and  another  twenty  years  will  see  as 
wide  a  pro  rata  distribution  to  the  total  holdings  as  any  class 
of  securities  exclusive  of  municipal  securities.  The  influence  of 
commission  regulation  and  the  changed  policy  of  publicity,  and 
the  effort  to  court  public  favor,  have  probably  been  of  as  great 
importance  in  effecting  this  change  of  public  attitude  as  have 
any  influences. 

"Where  the  capitalization  is  reasonable  and  the  management 
likewise  conservative,  the  advantage  in  a  narrow  range  of  price 
fluctuations  is  soon  appreciated  by  the  conservative  investor. 
And  when  the  basis  of  regulation  is  better  understood  so  that 
due  allowance  is  made  for  equitable  returns  under  the  varying 
conditions  affecting  individual  electric-light  corporations,  the 
effect  on  market  distribution  of  all  well-managed  companies  will 
be  far-reaching. 

'Electrical  World,  vol.  Ixii  (1913),  p.  535. 


CHAPTEE  XXI 
GAS  COMPANY  BONDS 

History  and  Present  Position. — The  initial  use  of  gas  for 
lighting  in  the  United  States  was  made  by  Mr.  David  Melville 
of  Newport,  Rhode  Island,  who  employed  coal  gas  for  lighting 
his  own  house  in  1806.1  The  first  commercial  gas  company, 
however,  was  not  organized  till  ten  years  later  in  Baltimore. 
Boston  and  New  York  City  followed  in  1821  and  1822 ;  Brook- 
lyn, New  York,  and  Bristol,  Rhode  Island,  in  1825;  and  New 
Orleans,  in  1853.  The  slow  development  of  gas-lighting  is  illus- 
trated by  the  action  of  Boston,  which  after  ten  years  had  only 
twenty  public  gas  lights,  and  it  was  not  until  after  1850  that 
any  considerable  advancement  in  the  industry  took  place.  Vig- 
orous opposition  was  made  against  the  building  of  gas  works  on 
the  grounds  that  they  endangered  the  health  and  the  lives  of  the 
people.  As  late  as  1833  the  city  council  of  Philadelphia  received 
a  petition  signed  by  several  hundred  people  protesting  in  most 
vigorous  terms  against  the  use  of  gas.  Petitions  of  similar  char- 
acter were  also  filed  with  the  councils  of  other  cities  and  towns. 

Serious  obstacles  in  the  development  of  new  companies  were 
also  experienced  in  the  difficulty  of  securing  capital.  The  only 
experience  the  public  had  had  with  public  utilities  was  with 
the  water-works  companies,  many  of  which  had  not  had  an 
enviable  reputation,  and  the  public  was  skeptical  of  the  out- 
come. Internal  improvements  during  this  initial  period  were 
also  making  a  strong  bid  for  capital  and  the  public  was  so 
possessed  with  the  idea  of  quick  and  extraordinary  wealth,  that 
investors  often  placed  all  their  available  funds  in  purely  ' '  paper 
enterprises."  This  lack  of  capital,  and  the  ignorance  of  the 


1William  Murdoch  in  1798  lighted  the  Soho  Foundry  at  Birmingham, 
England,  with  gas.  (W.  J.  A.  Butter  field,  Lectures  on  the  Chemistry  of 
Gas  Works  [1913]  p.  17.) 

388 


GAS  COMPANY  BONDS  389 

commercial  operation  of  gas  plants  especially  in  the  attempts 
to  operate  too  small  plants  were  followed  by  a  large  number  of 
failures1  of  gas  companies  which  gave  a  decided  set-back  to  the 
industry  for  several  years.  As  a  result  of  these  handicaps,  the 
number  of  gas  plants  up  to  1850  had  only  reached  thirty  with  a 
capital  of  $6,674,000,  and  an  output  valued  at  $1,921,746.  The 
greatest  development  came  after  1885  when  the  competition  of 
oil,  natural  gas  and  electricity  forced  the  development  of 
cheaper  processes  for  manufacturing  artificial  gas.  Prior  to 
this,  by-products  which  now  are  utilized  and  greatly  reduce  the 
cost  of  production  were  discarded  as  useless,  thus  making  the 
high  production  costs  of  gas  a  serious  obstacle  to  it  use. 

Less  than  one-half  of  the  cities  and  towns  in  the  United 
States,  over  1,500,  have  artificial  gas  manufacturing  plants,  and 
approximately  one-third  of  the  gas  manufacturing  companies 
are  operated  in  connection  with  electric-light  plants.  The  most 
recent  compilation  by  Mr.  Lansley,  which  is  already  old,  gives 
the  growth  from  1850  by  decades  to  1910. 

Number  of  Capital  Value  of 

Year  Individual  Plants1  Employed  Annual  Product 

1S50  30  $      6,074,000  $     1,921,746 

1890  742  258,772,000  56,987,000 

1900  877  567,000,000  75,717,000 

1910  1296  915,537,000  166,814,000 

3920  (estimated)   1400  1,100,000,000  225,000,0002 

The  increase  in  the  total  income  from  1900  to  1920  was 
approximately  six  times  that  of  the  previous  decade.  And  this 
increase  in  income  from  1900  to  1920  was  secured  in  face  of  a 
reduction  in  the  price  of  gas.  The  extension  in  the  number  of 
companies  from  1900  to  1910  was  nearly  one-half  of  the  total 
increase  in.  the  number  of  companies  for  the  previous  fifty  years 
from  1850  to  1900.3  The  extraordinary  growth  in  gross  income 
of  recent  years  has  largely  resulted  from  the  industrial  uses  of 
gas  by  manufacturers  together  with  the  increase  of  the  by- 


'Arthur  L.  Hunt.  Ticelfth.  United  States  Census  Manufacturers, 
Vol.  X,  Part  IV.,  p.  713,  and  Thirteenth  Census,  Vol.  X.  p.  637. 

2On  estimated  growth  of  the  previous  ten  years  (author's  estimate). 

'Arthur  L.  Hunt,  in  Twelfth  Census,  on  Manufactures,  vol.  x,  Part 
IV.,  p.  703. 


390  INVESTMENT  ANALYSIS 

products  which  have  been  developed  in  the  industry.  Gas  can 
be  used  in  generating  all  other  types  of  power  and  will  produce 
more  heat  and  power  from  a  ton  of  coal  than  could  be  produced 
if  the  same  ton  of  coal  were  used  directly  for  this  purpose.  The 
phenomenal  increase  in  the  use  of  fuel  gas  engines  since  1900 
is  itself  demonstrative  of  the  future  industrial  possibilities  of 
gas. 

The  perfections  in  the  refinement  of  crude  oil  which  greatly 
reduced  the  price  of  kerosene  oil  and  the  improvements  in  oil 
lamps  about  the  middle  of  the  last  century  brought  the  first 
serious  competition  to  the  use  of  gas.  In  spite  of  its  greater  con- 
venience, gas  at  the  ruling  high  prices  was  not  able  to  compete 
with  kerosene  oil  at  its  prevailing  low  price.  Also  the  utilization 
of  the  residues  of  gas  production,  which  now  makes  it  possible  to 
sell  gas  so  cheaply,  were  then  almost  wholly  unknown. 

When  the  use  of  artificial  gas  again  began  to  increase  under 
the  stimulus  of  the  improvements  instituted  after  1880,  elec- 
tricity, the  most  powerful  competitor  of  gas,  entered  the  field. 
The  cheaper  installation,  cleanliness,  convenience  and  cheapness 
of  electricity  soon  forced  it  to  the  forefront.  About  the  same 
time,  natural  gas  was  piped  into  the  cities,  and  the  cheapness 
with  which  the  installation  could  be  made  forced  a  number  of 
artificial  gas-plants  out  of  business.  But  the  frequent  short  life 
of  the  natural  gas  supply  has  in  most  places  sooner  or  later 
caused  the  cessation  of  operation  and  again  forced  the  use  of 
artificial  gas.  Though  natural  gas  was  used  as  early  as  1821 
for  lighting  the  village  of  Fredonia,  New  York,  it  did  not 
become  an  active  public  utility  until  1833.1  Twenty-one  states 
now  produce  it  in  varying  quantities,  though  only  five  can  be 
termed  large  producers,  namely,  Indiana,  Kansas,  Ohio,  Penn- 
sylvania, and  West  Virginia.  The  great  draw-back  with  the 
natural  gas  companies  is  sudden  exhaustion  of  the  supply  which 
may  take  place  at  any  time.  This  is  especially  true  where  sev- 
eral municipalities  use  the  same  supply.  Corporations  which 
supply  natural  gas  and  do  not  make  provision  for  the  ultimate 
exhaustion  of  their  gas-wells  must,  of  course,  lose  their  original 


^Special  Reports,  United  States  Census,  Mines  and  Quarries,  1902, 
p.  773  seq. 


GAS  COMPANY  BONDS  391 

investment.  The  chief  safeguard  is  the  purchase  of  a  large 
group  of  scattered  properties  and  the  ownership  of  some  arti- 
ficial plants,  together  with  ample  provision  for  the  future  con- 
struction of  additional  artificial  gas-plants.  Proof  of  the  rapid 
diminution  of  natural  gas  is  evidenced  by  the  fact  that  five 
times  the  quantity  of  natural  gas  was  used  in  1888  as  in  the 
last  ten  years.1  Also,  where  the  gas  must  be  piped  long  dis- 
tances, there  is  danger  of  litigation  ;  especially  is  this  true  where 
the  owners  of  the  production  company  may  be  a  distinct  organi- 
zation from  the  piping  company.  As  no  natural  gas  is  stored, 
the  piping  system  must  be  of  sufficient  capacity  tp  furnish  an 
adequate  supply.  Where  large  supplies  of  natural  gas  exist,  it 
is  extensively  used  for  heating  as  well  as  for  industrial  pur- 
poses ;  hence  the  consumption  becomes  very  large  in  the  winter 
months.  So  serious  has  been  the  danger  of  inadequate  supply 
in  winter  in  certain  localities  that  industrial  plants  use  gas 
only  during  the  summer  months.* 

Competition  with  other  forms  of  lighting,  however,  has  en- 
larged the  use  of  gas  by  stimulating  the  inventions  for  cheap 
production,  especially  the  cheapened  process  of  manufacturing 
water-gas  which  has  led  to  an  increasing  consumption  of  it  for 
cooking  and  industrial  purposes.  People  have  also  become 
accustomed  to  the  use  of  electricity,  and  this  has  also  encour- 
aged the  further  use  of  gas.  The  hope  for  the  greater  expan- 
sion of  this  industry  for  the  existing  companies,  however,  lies 
in  the  extension  of  the  use  of  gas  for  fuel  and  heat. 

Industrial  Uses  and  By-Products.  —  There  are  five  kinds  of 
manufactured  gas,  which  are  principally  used  for  lighting, 
heating,  and  general  industrial  purposes.  They  are  coal-gas, 
coke  oven  gas,  carbureted  water-gas,  the  combinations  of  mixed 
gas,  and  oil-gas.  The  coal-gas  is  made  by  the  distillation  of  coal 
which  is  heated  in  retorts.  A  pound  of  coal  makes  about  five 
cubic  feet  of  gas,  which  have  a  heat  value  of  550  to  630  B.  t.  u. 
per  cubic  foot.3  The  coke  oven  gas,  which  is  really  a  coal-gas,  is 


"b.  t.  u.=The  British  thermal  unit  which  indicates  the  heat  neces- 
sary to  raise  one  pound  of  pure  water  at  39°  F.  one  degree. 


392  INVESTMENT  ANALYSIS 

a  by-product  of  the  manufacture  of  coke,  and  its  heating  value 
is  lower  than  that  of  the  coal-gas.  Water-gas  is  made  by  forc- 
ing steam  upon  glowing  fuel.  This  is  enriched  with  oils,  and  a 
gas  is  generated  which  is  known  as  carbureted  water-gas.  The 
heating  value  ranges  from  500  to  650  B.  t.  u.  per  cubic  foot. 
The  combination  of  any  of  the  above  forms  of  gas  is  called 
mixed  gas.  The  different  constituents  are  united  by  a  mechanical 
process.  In  or  near  some  of  the  oil  fields,  gas  is  made  out  of 
crude  oil.  The  greater  part  of  the  gas  used  for  lighting  pur- 
poses in  this  country  is  the  carbureted  water-gas.  If,  however, 
the  price  of  oil  continues  at  its  present  high  level,  water-gas 
will  not  have  the  advantage  it  possessed  over  coal  gas,  prior  to 
the  European  war,  unless  the  enrichers  are  eliminated.  With 
the  eventual  elimination  of  the  enrichers  of  water-gas  (petro- 
lum,  cannel  coal,  or  naphtha,  which  are  no  longer  needed)  and 
the  increased  use  of  mantles,  the  cost  of  water-gas  lighting  will 
be  greatly  reduced.1  Considerable  controversy  is  still  waged 
over  the  necessity  of  these  enrichers,  which  are  still  required  by 
all  franchises  or  city  ordinances.  Once  the  public  fully  appre- 
ciates the  distinction  between  the  light  and  heat  values  together 
with  the  use  of  incandescent  gas-lighting,  it  will  accept  the 
elimination  of  these  old  requirements.  The  Bureau  of  Mines 
has  also  found  a  number  of  cheap  grades  of  coal  that  will  pro- 
duce gas  but  give  a  low  heat  value;  this  difficulty  no  doubt 
will  eventually  be  overcome  by  chemists. 

The  important  residuals  or  so-called  by-products  of  the  arti- 
ficial gas  manufacturing  industry  are  now  considerable  in  num- 
ber, and  the  limit  has  not  yet  been  reached.  The  war  demand  in 
the  United  States  for  chemicals  which  were  formerly  secured 
from  Continental  Europe,  especially  Germany,  stimulated  the 
chemists  in  this  country  to  search  for  the  recovery  of  by- 
products. Much  of  the  skill  which  was  directed  to  the  recovery 
of  chemicals  for  explosive  purposes  is  now  being  utilized  in  ex- 


*The  Annual  Report  of  the  Peoples  Gas  Light  and  CoTte  Company 
for  1916,  p.  8  (Chicago,  111.),  states:  "An  increase  of  Ic  per  gallon  in 
the  price  of  gas-oil  means  an  increase  of  nearly  5c  per  1,000  of  gas 
made  or  an  annual  expense  of  approximately  $800.000  (more  than  2% 
on  outstanding  capital  stock  of  the  company" — [$38,500,000] ).  If  public 
utilities  would  publish  more  facts  of  this  character  it  would  do  more 
than  anything  else  to  create  the  goodwill  of  the  public. 


GAS  COMPANY  BONDS  393 

perimenting  on  the  gas  wastes  for  future  discoveries  of  chemi- 
cals for  industrial  purposes. 

The  more  important  by-products  from  the  coal-gas  industry 
are  coke,  carbon,  gas-tar,  ammonial  liquor,  and  the  spent  puri- 
fying materials,  either  lime  or  oxide.  In  the  production  of 
water-gas,  the  by-products  are  purifying  materials  and  tar,  with 
a  small  amount  of  ammonial  liquors ;  and  in  the  oil-gas  produc- 
tion, tar,  lampblack,  and  spent  purifying  materials.  Varying 
with  the  methods  and  processes  used,  the  ammonial  liquor  yields 
different  types  of  chemical  products.  The  profit  from  these  by- 
products also  depends  on  the  processes  and  methods  used. 
Because  of  the  importance  of  these  by-products  the  income  from 
by-product  sources  should  be  separated  from  the  income  from 
the  sale  of  gas.  This  is  necessary  to  determine  the  plant's 
efficiency  in  the  production  of  its  by-products  as  distinct  from 
the  sale  of  gas. 

The  major  part  of  the  artificially  produced  gas  used  for  fuel 
is  still  employed  in  households.  The  increase  of  gas  for  purely 
industrial  purposes  is  still  to  receive  its  larger  development 
With  the  increasing  cost  of  producing  coal,  the  higher  heat 
energy  of  gas  may  soon  offset  the  disadvantage  of  its  being 
higher  in  price  than  coal. 

Population  and  Its  Relation  to  Service. — In  no  other  public 
utility  are  the  number,  character,  and  distribution  of  the  inhab- 
itants more  important  than  in  the  gas  companies.  It  is  rela- 
tively a  simple  matter  for  an  electric-light  company  to  adjust 
its  equipment  to  the  needs  of  outlying  territory,  but  with  a  gas 
company,  not  only  is  the  normal  outlay  for  construction  greater, 
but  adjustments  can  be  made  only  within  very  narrow  limits. 
The  more  concentrated  and  at  the  same  time  evenly  distributed 
the  population  is,  the  more  effectively  can  the  distributing 
mains  be  utilized ;  and  the  larger  the  quantity  of  gas  consumed, 
ths  cheaper  can  gas  be  manufactured.  An  examination  of  the 
population  and  its  distribution  then  becomes  our  first  consid- 
eration in  a  study  of  gas  securities. 

An  examination   of   eighty   companies   selected   at  random 
throughout  the  United  States  shows  most  conclusively  that  the 


394  INVESTMENT  ANALYSIS 

cost  of  producing  gas  in  cities  below  60,000  increases  approxi- 
mately at  an  inverse  ratio,  as  the  cities  decrease  in  size.1  The 
limit  of  60,000  is  probably  not  an  absolute  one,  but  the  rela- 
tion between  the  decrease  in  cost  of  production  and  the  increase 
in  population  is  beyond  dispute.  With  four  exceptions,  towns 
below  this  limit  sold  gas  at  a  higher  rate.  All  of  the  cities  below 
50,000  population  showed  a  rate  from  one  and  one-half  to  as 
high  as  slightly  over  three  times  as  great  as  the  cities  with  over 
70,000  inhabitants.  In  the  majority  of  cases,  there  also  seems 
to  be  a  very  positive  tendency  in  this  group  of  cities,  where 
data  were  available,  for  a  fairly  direct  ratio  of  decreased  costs 
with  increase  in  concentration,  but  sufficient  data  could  not  be 
obtained  to  warrant  the  assumption  of  a  principle  in  relation- 
ships, though  the  tendency  seems  quite  positive,  and  logically 
this  would  be  the  expected  result.  A  very  widely  scattered  city 
will  also  discount  very  appreciably  the  advantage  which  the  city 
may  have  in  larger  numbers. 

The  exceptions  to  these  general  principles  of  population  and 
cost  of  output,  as  with  all  principles  of  investment,  must  not  be 
overlooked.  For  example,  a  few  of  the  Southern  cities  with  a 
very  large  poor  colored  population  will  compare  unfavorably 
with  a  New  England  city  of  similar  size.  This  is  especially 
evident  where  this  poorer  population  is  scattered  through  vari- 
ous sections  of  the  city  and  thus  affects  a  low  return  on  the 
main  mileage,  whereas,  if  this  population  is  concentrated,  the 
gas  mains  are  more  effectively  used.  To  the  extent  to  which 
economy  of  distribution  is  procured  the  latter  handicaps  are 
overcome.  But  where  distribution  or  the  character  of  the  popu- 
lation does  destroy  the  operation  of  these  principles,  it  is  a  rela- 
tively easy  matter  to  discover  the  causes  for  these  differences. 

To  the  investor,  the  fact  of  immediate  importance  is  that 
very  few  towns  operate  gas  companies  as  a  municipal  enter- 
prise. Practically  all  of  the  very  small  non-dividend  companies 
are  owned  by  local  interests  and  fostered  by  one  or  more  pub- 


JThis  is  also  borne  out  by  the  quotation  cited  from  Mr.  Rufus  C. 
Dawes  and  also  by  the  reports  of  the  State  Commissioners  of  Gas  and 
Electric  Light  Companies  in  Massachusetts  within  slightly  different 
limits.  The  data  for  the  latter  may  be  procured  from  the  Massachusetts 
Board  of  Gas  and  Electric  Light  Commissioners,  the  most  complete  and 
accurate  of  any  of  the  state  commission  reports. 


GAS  COMPANY  BONDS  395 

licly  interested  individuals.     Among  the  non-dividend  paying 
companies  of  the  higher  population  group,  other  causes  exist. 

While  the  same  general  tendencies  are  to  be  found  in  the 
earnings  of  natural  gas  companies  in  relation  to  population,  the 
ratios  are  entirely  different.  The  tendency  for  the  ratio  of 
margins  to  increase  with  the  increased  output,  however,  is  very 
much  greater  in  natural  gas  companies  than  in  artificial  gas 
companies.  There  are  so  many  variables  entering  into  the  con- 
trol of  costs  of  natural  gas  that  while  this  tendency  is  very  pro- 
nounced in  the  whole  group,  there  may  be  wide  variations  in  the 
costs  within  each  division  of  companies  in  the  group.  But  this 
fact  only  necessitates  an  analysis  of  the  other  factors  used  in 
determining  the  values  of  gas  companies. 

Gas  Rates. — Gas  rates  until  recently  have  been  continually 
lowered  since  1850.  It  was  not  till  the  beginning  of  1915  that 
these  decreases  were  checked  as  with  all  public  utilities  under 
the  influence  of  the  enormous  increase  in  production  costs.  This 
reduction  was  brought  about  by  the  cheapened  process  of  gas 
production,  the  utilization  of  by-products,  and  the  competition 
of  electricity.  Contrary  to  popular  belief,  public  demand  for 
cheaper  rates  has  been  a  very  small  factor  in  this  movement; 
the  corporations  themselves  have  been  responsible  for  these 
reductions.  The  reason  is  obvious.  To  secure  sales,  the  com- 
petitive prices  of  electricity  had  to  be  met.  This  reduction  is 
the  more  interesting  in  that  it  has  been  maintained  in  face  of 
the  general  rise  of  prices  since  1897.1  The  striking  reduction  in 
the  price  of  gas  is  well  illustrated  by  the  experience  of  New 
York  City;  in  1826  the  price  was  $10.00  per  thousand  cubic 
feet;  in  1846,  $6.00;  in  1866,  $3.50;  in  1901,  $1.00;  and  in  1906, 
$.80,  for  general  public  lighting  purposes.2 

A  practice,  at  present,  in  charging  for  gas  is  to  use  the  slid- 
ing scale,  allowing  for  a  lower  price  with  the  increased  con- 
sumption of  gas.  Wholesale  rates  as  low  as  $.50  and  $.80  per 
thousand  for  artificial  gas  have  not  been  unusual  where  it  has 
been  used  for  both  fuel  and  lighting  purposes.  Under  the 


*TJie  Massachusetts  Cost  of  Living  Report  (1910),  p.  164  (House 
Doc.  1750).  See  also  last  United,  States  Census  Report. 

2For  other  prices  see  National  Civic  Federation  Report,  Part  II., 
vol.  i,  p.  470. 


396  INVESTMENT  ANALYSIS 

stimulus  of  competition  some  inventions  will  no  doubt  reduce 
the  price  of  gas  to  an  even  lower  level,  though  for  the  imme- 
diate present  this  is  impossible  with  the  increased  costs  of  raw 
products.  It  must  be  remembered,  however,  that  the  compari- 
son of  production  costs  and  gas  rates  and  general  prices  must 
always  be  relative.  While  a  number  of  companies  have  been 
forced  to  reduce  their  rates  by  city  councils  and  commissions, 
the  reductions  have  been  more  than  offset  by  the  gain  in  the 
economies  of  production.  Concerning  the  apprehension  before 
the  war  period  of  a  further  forced  lowering  of  gas  rates,  Mr. 
Lawrence  Chamberlain  states:  "From  a  careful  survey  of  the 
rates  of  one  hundred  and  seventy-two  companies  in  the  princi- 
pal cities  of  the  United  States,  extending  back  over  a  period  of 
twenty-three  years,  it  is  possible  to  state  with  authority,  that 
there  is  no  present  marked  acceleration  to  the  decline  in 
prices.  Rather  that  the  scaling  has  been  fairly  constant  for  the 
period  in  such  companies  as  had  to  meet  the  competition  of 
natural  gas.''1  Since  1918,  a  recognition  of  the  burden  of 
increased  costs  has  forced  a  positive  upward  trend  in  rates. 
Some  municipal  administrations,  due  to  political  pressure,  have 
failed  to  respond  as  quickly  as  they  should  to  the  companies' 
needs  for  increased  rates,  but  this  attitude  cannot  long  continue. 
Earnings  and  Cost  of  Production. — The  form  of  Income 
Statement  recommended  by  the  American  Gas  Institute2  is 


Lawrence    Chamberlain,    Principles    of   Bond  Investment    (1911), 
p.  344. 

'INCOME  STATEMENT* 
(Only  main  headings  given) 

Operating  Revenue  Promotion  Expenses 

Gas  Sales  Commercial  Expenses 

Street  Lighting  Sales  General  Expenses 

Municipal  Buildings  used  by          Street  Lighting  Expenses 

company  Taxes 

Operating  Expenses  Total  Operating  Expenses 

Coal  Gas  Production  Non-Operating  Revenues 

(Less  Residuals)  Total  Net  Operating  and  Non- 

Water  Gas  Production  Operating  Revenues 

(Less  Residuals)  Income  Deductions 

Total  Coal  Gas,  Water  Gas  and         Interest 
Gas  Purchased  Rentals 

Distribution  Expenses  Sinking  Funds 

(Includes  Maintenance)  Payment  of  Dividends 

Rendered  to  Profit  and  Loss 

*Report  of  the  Committee  of  American  Gas  Institute  on  a  Uni- 
form System  of  Accounts  for  Gas  Companies  (September,  1914,  p.  128). 


GAS  COMPANY  BONDS  397 

sufficiently  detailed  and  comprehensive  for  one  to  make  a  close 
analysis  of  the  source,  character  and  relationship  of  earnings, 
expenses  and  charges.  Not  many  gas  companies,  however,  give 
sufficiently  detailed  income  statements  to  furnish  this  essential 
information.  Balance  sheets  and  property  accounts  more  fre- 
quently contain  complete  enough  data  to  warrant  positive  con- 
clusions as  far  as  fixed  assets  are  concerned.  But  without  an 
income  statement,  few  worth-while  deductions  of  any  conse- 
quence can  be  obtained. 

The  most  comprehensive  test  of  the  effectiveness  of  earnings, 
in  relation  to  both  property  and  capitalization,  is  made  by 
means  of  unit  comparisons.  Aggregates  in  the  income  state- 
ment are  valuable  for  estimating  the  whole,  but  they  do  not  as 
quickly  reveal  the  particular  points  of  weakness  or  strength 
which,  as  already  demonstrated,  are  what  an  analysis  must  give 
or  fail  in  its  purpose. 

Technical  unit  analyses  for  gas  companies  have  the  same  pur- 
pose as  for  other  utilities.  In  the  application  of  these  units, 
the  limitations  of  their  use  must  be  observed  both  in  the  com- 
parisons of  different  years  of  a  company's  own  record,  and  in 
the  comparisons  with  other  companies.1  Peculiar  local  condi- 
tions, changes  in  rates,  growth  of  city,  size  of  company,  new 
inventions,  and  processes  of  productions,  etc., — all  will  necessi- 
tate a  different  emphasis  upon  particular  units.  The  operating 
rates  and  other  technical  factors  applying  to  the  general  report 
of  any  company  should  also  be  applied  in  the  analysis  of  the  gas 
company,  together  with  the  special  features  already  discussed. 

The  population  per  mile  of  main  and  consumers  per  mile  of 
main  are  measures  of  the  effectiveness  with  which  the  company 
is  serving  the  community.  If  the  quota  of  population  per  mile 
of  main  is  large  and  the  number  of  consumers  is  small,  it  indi- 
cates either  that  the  company's  selling  organization  is  defective 
(and  this  is  a  reflex  of  its  whole  organization)  or  that  prices 
are  prohibitive,  or  that  the  character  of  the  population  may  not 
allow  a  very  high  rate  of  consumption.  If  both  consumers  and 
population  are  large,  effective  distribution  is  signified,  but  this 
may  also  mean  that  the  maximum  expansion  has  been 


Rational  Civic  Federation  Report,  1907,  Part  I.,  vol.  i,  p.  208. 


398  INVESTMENT  ANALYSIS 

approached  unless  the  city  is  rapidly  growing  or  the  rates 
are  .lowered  for  industrials.  If  population  and  consumers  are 
both  low  per  mile  of  main,  it  suggests  that  the  population 
is  either  widely  or  unevenly  distributed.  When  the  ratios 
of  population  and  consumers  are  known,  another  basis  is 
given  upon  which  may  be  checked  the  amount  of  the  capi- 
tal expenditures,  as  well  as  administration  and  operating 
expenses.  Normally,  as  stated  in  a  subsequent  quotation 
from  Mr.  Rufus  C.  Dawes,  a  very  decided  tendency  to  increase 
is  to  be  expected  in  the  proportionate  outlay  of  expenditures 
to  earnings  as  the  cities  increase  in  size  above  50,000 
inhabitants. 

Sales  per  unit  of  main  may  not  necessarily  be  a  standard 
base  for  comparison.  If,  for  example,  prices  should  vary  or  the 
proportion  of  gas  at  lower  prices  for  industrial  purposes  be 
increased  relative  to  the  total  consumption,  any  comparison  of 
sales  would  be  totally  misleading.  If  the  sales  for  lighting  and 
industrial  purposes  can  be  separated  and  the  proper  allowances 
are  made  for  these  differences,  the  sales  unit  becomes  a  valuable 
measure  of  a  company's  growth.  It  is  well  under  any  condition 
to  have  all  of  the  important  sources  of  income  separate.  A 
more  accurate  measure  per  mile  of  main  measurement  is  found 
in  the  net  profits.  The  final  fact  which  the  investor  wants  to 
know  is  the  net  yield  on  his  investment,  and  regardless  of  what 
other  exceptions  must  be  made,  the  net  return  requirement  can- 
not be  qualified. 

Per  capita  earnings  and  per  consumer  earnings,  frequently 
used  to  measure  the  effective  utilization  of  the  property  invest- 
ment, may  be  useful  checks  to  the  mile  of  main  measurements, 
but  so  many  qualifications  must  be  observed  that  it  is  doubtful 
whether  they  should  often  be  used.  Errors,  however,  are  less  apt 
to  occur  in  their  use  in  this  connection  than  with  electrical  prop- 
erties. 

What  has  been  said  of  population,  earnings,  and  the  cubic 
feet  of  gas  sold  per  mile  of  main  also  applies  to  total  capitaliza- 
tion and  its  separate  items  of  bonds  and  stocks  and  the  amount 
of  the  property  investment.  The  only  advantage  which  this 


GAS  COMPANY  BONDS  399 

method  of  testing  possesses  over  a  direct  comparison  is  the  one 
so  often  mentioned — it  makes  a  more  comparable  basis  of  esti- 
mate for  the  average  analyst. 

Mr.  Eufus  C.  Dawes  in  an  address  before  the  Investment 
Bankers  Association  well  summarized  the  uses  and  limitations 
of  these  measurements  in  a  discussion  of  the  cost  of  production : 
"Such  items  of  operating  costs  as  interest  and  dividends 
required,  also  maintenance,  and  in  a  large  measure,  general  dis- 
tribution and  administration  expenses,  bear  a  fixed  ratio  to  the 
mileage  of  mains  or  capital  invested — none  necessarily  to  the 
amount  of  gas  sold.  Take  a  company  in  a  certain  state  of  de- 
velopment, double  its  business  and  you  reduce  the  cost  per 
thousand  feet  to  manufacture.  But  the  cost  of  manufacturing 
gas  rarely  exceeds  one-third  the  total  cost  of  gas  delivered,  in- 
cluding a  fair  rate  of  return.  A  material  increase  in  sales 
without  a  material  increase  in  mileage  mains,  decreases  the  cost 
of  items  aggregating  two-thirds  of  the  total  cost,  in  almost  an 
inverse  ratio.  In  many  places  in  this  country,  natural  gas  is 
being  sold  at  rates  so  low  as  to  displace  coal  as  fuel.  In  such 
places,  it  may  interest  you  to  know  that  the  cost  per  thousand 
feet  of  such  items  as  interest,  maintenance,  distribution,  and 
administration  is  about  five  per  cent  of  the  cost  per  thousand 
feet  of  the  samo  items  for  artificial  gas,  for  the  reason  that  at 
such  prices,  there  is  about  twenty  times  as  much  natural  gas 
sold  per  mile  of  mains  as  there  is  of  artificial  gas.  The  lower 
prices  in  these  cases  brought  a  larger  output  per  mile  of  mains 
and  established  a  lower  cost  per  thousand  feet,  so  that  the  cost 
per  thousand  feet  of  gas  was  determined  chiefly  by  the  price  at 
which  it  was  sold.  .  .  .  But  before  prices  are  reduced  the  cost 
of  the  service  to  be  displaced  must  be  studied,  for  a  reduction 
in  price  that  is  not  accompanied  by  an  increase  in  business 
would  merely  reduce  net  earnings." 

Costs  of  production  for  the  smaller  cities  and  towns  are  also 
decidedly  affected  by  their  proximity  to  the  source  of  their  raw 
supplies.  A  study  of  the  geographic  location  of  the  largest 


'Rufus  C.  Dawes.  Proceedings  of  the  Third  Annual  Con  rent  ion  of 
the  Investment  Bankers  Association,  Philadelphia,  November.  1014. 
p.  184. 


400  INVESTMENT  ANALYSIS 

cities  will  show  that  they  are  located  near  coal  supplies  or  are 
in  touch  with  these  supplies  by  short  and  cheap  water  transpor- 
tation. Many  of  the  smallest  plants,  regardless  of  other  advan- 
tages they  possess,  must  always  operate  under  this  handicap 
and  the  higher  price  they  must  pay  for  smaller  quantities  of 
raw  products.  While  general  cost  figures,  especially  in  these 
days,  must  be  used  with  caution,  they  offer  some  suggestions. 
The  Massachusetts  Board  of  Gas  and  Electric  Light  Commis- 
sioners, to  which  every  one  is  eventually  forced  to  resort  for 
data  which  may  be  considered  reliable,  gives  much  interesting 
and  valuable  data  to  any  one  desiring  more  complete  knowledge 
of  gas  company  finances  and  costs. 

Capitalization  and  Property  Accounts. — In  the  commercial 
companies  the  distribution  of  the  investment  is  approximately 
as  follows  for  the  United  States  as  a  whole:  30  to  35  per  cent 
in  common  stock  and  5  per  cent  in  preferred  stock.  With  the 
increase  in  the  size  of  the  company,  bonds,  as  a  rule,  form  a 
larger  proportion  of  the  capitalization.  While  the  value  of  the 
output  has  increased  approximately  150  times,  rates  have 
decreased  from  an  average  of  $6.00  per  1,000  cubic  feet  in  1850 
to  an  average  of  less  than  $2.00. 

As  with  electric  light  companies,  the  persistent  lowering  of 
rates  on  the  companies'  own  initiative  tells  the  story  of  the 
increased  efficiency  in  the  utilization  of  the  capital  funds.  But, 
again,  the  rapidly  changing  prices  of  materials  and  the  uncer- 
tainty of  the  regulation  of  rates  make  these  conditions  one  of 
the  most  important  qualifications  to  any  conclusion  affecting 
capitalization.  Even  prior  to  the  European  war,  the  average 
rate  of  return  for  the  country  on  capital  stock  was  not  ade- 
quate. The  small  non-paying  companies,  which  would  not  be 
included  in  the  investment  group,  are,  of  course,  accountable 
for  bringing  this  average  down.  The  only  fair  generalization 
would  be  an  average  of  the  companies  which  could  be  included 
in  the  investment  group. 

The  lack  of  separation  of  the  items  of  land,  buildings,  and 
other  property  accounts  in  the  great  majority  of  financial  state- 
ments, often  necessitates  a  revamping  of  these  accounts  to  make 


GAS  COMPANY  BONDS  401 

a  complete  analysis  possible.  Without  this  kind  of  statement 
no  estimate  can  be  made  of  the  adequacy  of  the  depreciation 
accounts.  In  the  incomplete  statement,  the  net  book  value  can 
be  given  unwarranted  emphasis,  as  the  property  account  may 
never  have  been  depreciated.  This  separation  is  valuable  from 
the  standpoint  not  only  of  analyzing  the  particular  accounts, 
but  also  of  discovering  the  weak  places  in  the  management. 
While  the  system  might  fulfill  all  normal  requirements,  other 
parts  of  the  investment  in  the  property  might  be  inadequate, 
i.  e.,  out  of  proportion  to  the  standard  requirements.  With 
the  exception  of  those  of  the  Massachusetts  Board  of  Gas  and 
Electric  Light,  state  reports  shed  little  light  on  this  problem  and 
offer  little  in  the  way  of  concrete  guidance. 

The  average  ratio  of  land  and  buildings  to  the  total  invest- 
ment is  about  20  per  cent,  while  machinery,  tools,  and  other 
equipment  total  about  65  to  70  per  cent,  with  current  assets 
making  up  the  balance.  In  the  second  group  of  items,  the 
ratio  has  been  growing  larger  owing  to  the  increase  in  the 
manufacture  of  by-products ;  and  this  ratio  is  likely  to  continue 
on  the  up-grade.  Any  increase  of  expenditure  for  fixed  prop- 
erty beyond  the  normal  ratio  to  the  quantity  of  gas  sold  should 
result  in  more  than  a  proportionate  increase  in  the  returns  from 
the  by-products,  to  warrant  these  expenditures. 

The  continuous  peak  load  in  production  is  just  as  essential 
in  gas  production  as  in  electric  lighting  companies  if  the  most 
efficient  utilization  of  the  plant  is  to  be  secured.  On  the  other 
hand,  when  large  expansions  are  to  be  made,  the  same  elastic 
adaptation  cannot  always  be  made  to  the  immediate  as  well  as 
future  requirements  of  gas  companies  as  easily  as  with  electric 
lighting  companies.  Greater  costs  in  gas  equipment  are  necessi- 
tated by  the  more  permanent  and  larger  anticipation  of  future 
expansion,  so  that  the  immediate  rate  may  not  only  be  cut  in 
proportion  to  capital  expenditures  but  the  attaining  of  "ex- 
pected returns"  on  the  new  expenditures  is  slower.  This  condi- 
tion makes  it  the  more  difficult  to  estimate  the  limitations  on 
expansions  in  order  not  to  go  beyond  the  saturation  point.  A 
decreasing  growth  in  the  volume  of  business  must  not  necessarily 


402  INVESTMENT  ANALYSIS 

be  viewed  with  alarm  any  more  with,  gas  companies  than  with 
electric  light  companies,  though  it  must  be  considered  in  ana- 
lyzing capital  expenditures.1 

Depreciation. — Of  most  immediate  interest  in  the  deprecia- 
tion and  maintenance  of  gas  plants,  as  with  other  public  utili- 
ties, is  the  relation  of  these  factors  to  rates.  The  testimony  of 
experts  and  the  judicial  decisions  are  somewhat  in  conflict. 
Presumably  the  only  safe  means  of  insuring  accuracy  concern- 
ing a  particular  company  is  an  examination  of  the  public 
utility  commission  and  court  decisions  of  the  state  having  ju- 
risdiction over  the  company.  Fortunately,  this  information  is 
not  difficult  to  obtain,  though  it  is  not  always  complete.  If  this 
is  the  safest  guide,  it  is  not  necessary  to  discuss  the  method 
or  justice  of  the  method  here,  but  merely  to  ascertain  whether 
the  company  has  adequately  complied  with  the  statutes  or 
decisions  of  the  governing  bodies.  Whether  the  amount  de- 
ducted for  depreciation  is  sufficient  to  cover  requirements, 
should,  of  course,  be  checked. 

In  the  case  of  the  Lincoln  Gas  and  Electric  Company,  Jus- 
tice Luston  states:  "Heretofore,  it  seems  to  have  been  so  well 
and  continuously  done  that  the  value  of  the  plant  as  a  whole 
has  suffered  less  than  one  per  cent  per  annum,  if  the  total 
depreciation  be  distributed  through  more  than  thirty  years  of 
operation."  In  the  Cedar  Rapids,  Iowa,  gas  rate  case,  the 
court  states  that  1.7  per  cent  of  the  value  of  the  plant  per 
annum  put  in  a  4  per  cent  sinking  fund,  would  reproduce 
the  plant  in  thirty  years.3  Mr.  William  J.  Hagenah,  in  his 
report  on  the  People's  Gas  Light  and  Coke  Company,  fixes 
the  depreciation  on  the  basis  of  earnings  as  follows :  ' '  On  the 
basis  of  the  above  composite  life  of  thirty-five  years  and  the 
assumption  that  an  accumulation  for  depreciation  would  be 
able  to  earn  4  per  cent,  it  would  be  necessary  to  set  aside  for 
this  purpose,  l1/^  per  cent  of  the  total  depreciable  property  each 


See  Capital  and  Property  Account  of  Electric  Light  Companies, 
chap.  xx. 

2Lincoln  Gas  and  Electric  Light  Co.  vs.  City  of  Lincoln,  223  U.  S. 
349.  Feb..  1012. 

"Cedar  Rapids  Gas  Light  Co.  vs.  Cedar  Rapids,  Towa,  426,  120  X.  W., 
May,  1909. 


GAS  COMPANY  BONDS  403 

year  .  .  .  While  this  amount  would  be  sufficient  to  meet 
replacements  as  they  normally  occur,  it  is  probably  due  to  the 
uncertainties  of  a  business  which  extends  over  seventy  years 
into  the  future  that  some  allowance  must  be  made  for  contin- 
gencies ...  an  annual  allowance  of  2  per  cent  on  the  depre- 
ciable property  is  sufficient  to  cover  this  requirement."1  The 
Massachusetts  statutes  for  municipal  lighting  plants  require  an 
allowance  of  3  per  cent  on  the  cost  of  the  plant  exclusive  of 
land  and  water  power.  This  may  be  decreased  or  increased  by 
the  Board  of  Gas  and  Electric  Light  Commissioners/ 

Special  Features  of  the  Gas  Franchise. — The  serious  objec- 
tions to  the  gas  plant  in  any  locality  and  to  more  gas  mains  in 
the  streets  than  are  necessary,  because  of  the  additional  dangers 
involved,  have  resulted  in  the  granting  of  more  exclusive  privi- 
leges in  the  franchises  of  gas  companies,  as  a  class,  than  to  any 
other  public  utility.3  These  privileges  were  especially  broad  in 
some  of  the  earlier  charters  which  were  granted  by  special  leg- 
islative enactments.  As  gas  organizations  first  originated  dur- 
ing the  period  of  charter  grants  by  special  legislation,  the  pow- 
ers, because  of  political  influences,  were  likely  to  be  much  less 
limited  than  under  the  later  general  corporation  law. 

Many  of  the  later  franchises  provide  for  the  purchase  of  the 
company's  property  and  franchise  by  the  city,  and  often  give 
in  considerable  detail  the  conditions  under  which  the  plant  can 
be  purchased.  The  fault  with  many  of  these  details  is  their 
vagueness  concerning  the  valuation  which  shall  be  placed  upon 
the  property  for  purchase  by  the  city.  These  clauses  are  also 
becoming  increasingly  important,  as  more  emphasis  is  now 
placed  upon  property  values  and  capitalization  as  a  basis  for 
rate  purposes.  It  is  not  likely,  however,  that  a  company  would 
suffer  long  from  too  low  rates  even  under  such  a  franchise  as 
that  granted  Saginaw,  Michigan,  which  gives  the  city  the  right 
to  regulate  the  price  at  intervals.  It  may  temporarily  feel  the 


'William  J.  Hagenah,  Report  on  People's  Light  Gas  $  Coke  Co., 
made  to  the  Chicago  City  Council  Committee  on  Gas,  Oil  and  Electric 
Light.  April  17.  1911. 

'Massachusetts  Revised  Statutes,  1908.  chap.  486. 

"Delos  F.  Wilcox.  Municipal  Franchises,  vol.  i,  p.  536. 


404  INVESTMENT  ANALYSIS 

pressure  during  such  a  period  of  rising  prices  as  that  following 
the  outbreak  of  the  World  War,  so  frequently  mentioned. 
Political  influences  may  temporarily  check  the  legitimate  price 
adjustment  by  wilfully  using  the  stock  arguments  that  the  gas 
company  is  a  trust  and  monopoly  usurping  public  rights.  Be- 
cause of  the  persistency  with  which  we  cling  to  customs,  the 
company's  rights  can  for  a  time  be  made  a  political  football. 
The  utility  in  the  long  run,  however,  has  succeeded  to  its  rights. 
Public  utilities  further  have  come  to  appreciate  the  value  of 
complete  publicity  which,  if  correctly  used,  will  lessen  more 
and  more  the  possibilities  of  these  hardships  upon  the  company. 
The  last  ten  years  have  developed  a  public  viewpoint  which  will 
be  of  inestimable  value  to  all  classes  of  public  utilities.  Under 
both  the  pressure  of  public  opinion  and  the  check  of  the  higher 
courts,  commissions  have  come  to  a  realization  of  their  function. 
Again,  the  important  thing,  as  with  all  public  utility  control, 
is;  what  is  the  character  of  the  regulatory  statutes?  What 
commission  rulings  have  been  made  under  these  statutes  ?  Have 
the  higher  courts  sustained  the  rulings  of  the  commissions? 
Because  of  the  greater  age  of  the  gas  companies,  more  court 
decisions  exist  affecting  general  policies  and  fundamental  prin- 
ciples of  the  gas  rates  than  for  rates  of  other  utilities. 

The  question  of  rates,  as  affected  by  "heat-giving  and  light- 
giving"  qualities  and  pressure  as  included  or  not  included  in 
the  franchise  is  of  extreme  importance.  It  has  been  a  practice 
with  some  gas  companies  to  cheapen  the  quality  when  a  decrease 
in  rates  was  allowed  and  thus  maintain  the  margin  of  profits. 
Except  where  new  inventions  or  processes  have  made  cheaper 
production  possible,  continued  holdings  in  such  companies  are 
questionable,  unless  there  are  other  offsetting  factors,  for  a 
demand  for  better  quality  will  eventually  take  place  and  result 
in  a  lower  margin  of  profits. 

Bond  Characteristics,  Character,  Market  and  Yield. — These 
bonds  are  covered  by  a  wide  range  in  security,  and  can  satisfy 
demands  for  the  most  speculative  or  for  the  most  conservative 
risk.  They  extend  from  the  security  of  the  company  which  is 
merely  run  for  the  convenience  of  a  hamlet  to  that  of  the 
metropolis  of  New  York.  And  a  whimsical  investor  or  specu- 


GAS  COMPANY  BONDS  405 

lator  indeed,  he  would  be,  who  cannot  be  satisfied  with  a 
selection  in  this  catalogue  of  securities. 

In  recent  years,  gas  securities,  with  a  very  few  exceptions  of 
some  of  the  very  largest  companies,  have  never  been  as  favor- 
ably accepted  or  had  as  wide  a  market  as  other  public  utilities. 
A  large  group  of  conservative  investors  have  shunned  them 
altogether  for  a  number  of  years.  Three  reasons  may  account 
for  this  attitude :  First,  the  rapid  development  of  the  electrical 
industries  captivated  the  general  investing  public  by  their  future 
possibilities  and  high  yields,  and  this  condition  fostered  the 
idea  prevalent  in  the  early  days  of  electricity  that  gas  prop- 
erties would  as  a  result  be  stifled  under  the  uneven  competition, 
and  become  poor  paying  properties.  Secondly,  outside  of  the 
largest  companies,  the  majority  of  the  securities  have  never 
experienced  a  wide  market.  Thirdly,  the  localization  in  the 
marketing  of  the  first  securities  issued  by  gas  companies  con- 
tinued to  be  an  influence,  though  a  very  minor  one,  in  deter- 
mining the  market  for  new  securities  of  these  same  companies. 
But  because  of  the  ability  with  which  gas  companies  have  held 
their  own  and  despite  the  odds  against  which  they  had  to  com- 
pete with  electricity,  gas  securities  of  merit  are  now  coming 
into  their  own. 

The  set-back  they  have  suffered,  however,  since  1916  can  be, 
as  with  all  public  utilities,  only  temporary.  Price  adjustments 
must  be  made.  These  changing  attitudes  toward  gas  securities 
are  an  interesting  illustration  of  the  increasing  recognition  that 
the  adherence  to  sound  principles,  and  not  the  class  of  securities, 
determines  the  value  of  a  security. 

With  this  wide  range  in  the  classes  of  gas  bonds,  there  is,  as  a 
result,  a  considerable  range  in  the  net  yield.  The  cause  of  this 
variation  can  be  attributed  to  the  location  of  the  company, 
breadth  of  the  market,  and  the  convertibility,  this  latter  being 
largely  determined  by  the  preceding  condition.  The  yield,  the 
strength  of  security  having  been  determined,  must  be  dependent 
on  the  basis  of  whether  the  security  must  be  quickly  sold  or 
whether  it  is  to  be  held  till  maturity,  regardless  of  the  market 
changes. 

The  decided  advantages  in  the  purchase  of  bonds  of  the 


406  INVESTMENT  ANALYSIS 

larger  cities  should  again  be  suggested  in  relation  to  the  security 
of  the  bonds.  And  to  the  extent  of  this  influence  on  the  security 
of  the  bond,  the  ratio  of  the  indebtedness  to  the  value  of  the 
property  should  be  fixed.  To  state,  as  a  number  of  popular 
writers  have  done,  that  the  bonded  bebt  should  be  50  or  60  per 
cent  of  the  value  of  the  fixed  assets  may  be  absolutely  misleading. 
A  bonded  debt  of  75  per  cent  in  one  company  is  often  a  very 
much  safer  proposition  than  the  bonded  debt  of  30  per  cent  upon 
another  company.  Certainly  a  high  per  cent  of  funded  debt  upon 
a  well  managed  gas  company  in  a  city  of  half  a  million  would  be 
very  much  more  desirable  than  a  much  lower  bonded  debt  upon  a 
town  of  one  thousand  inhabitants  in  some  western  state.  The 
higher  rate  in  the  large  city  might  alone  be  warranted  because 
of  the  appreciation  of  values  due  to  the  growth  of  the  city.  The 
ratio,  as  in  every  other  company  must  be  fixed  on  the  basis  of  the 
status  of  the  company.  The  stability  which  the  higher  grade  of 
ga's  bonds  showed  in  the  panics  of  1903  and  1907,  and  the  de- 
pression of  1914,  removes  any  doubt  of  their  soundness  when 
well  selected. 


CHAPTER  XXII 
HYDRO-ELECTRIC  POWER  BONDS 

Development. — Water-power  for  industrial  purposes  has 
been  used  for  more  than  three  thousand  years.  From  the  time 
the  primitive  undershot  and  overshot  water  wheels  were  used 
till  the  turbine  water-wheel  was  introduced  and  electricity  could 
convey  this  power,  the  water-power  industry  developed  very 
slowly.  The  necessity  of  locating  the  factory  at  the  source  of 
power  before  the  introduction  of  electricity,  and  the  improve- 
ments in  steam  power  which  allowed  the  power-plant  to  be 
placed  at  any  desired  point,  led  to  the  adoption  of  the  latter. 
And  after  the  middle  of  the  last  century,  steam  power  soon  sur- 
passed the  water-power  plants.  As  late  as  1870,  water-power 
plants  furnished  48  per  cent  of  the  motive  force,  but  by  1907  the 
proportion  had  fallen  to  less  than  15  per  cent  of  the  total  motive 
power  in  the  United  States.  The  growth  in  water-power  plants 
after  1895  was  relatively  less  than  steam  power,  though  the 
aggregate  amount  shows  a  large  increase  resulting  from  im- 
provements in  the  transmission  of  electricity.1 

With  the  practical  commercial  application  on  a  large  scale 
of  the  alternating  current  by  the  Westinghouse  Electric  Com- 
pany in  1886,  which  enabled  the  operators  to  transmit  electricity 
for  both  light  and  power  over  a  considerable  area,  a  new  im- 
petus was  given  to  the  water-power  industry.  In  the  previous 
ten  years  several  local  plants  with  small  voltage  had  been  in- 
stalled which  utilized  the  existing  power  installations,  but  they 
were  used  only  for  the  local  factories  for  which  they  had  been 

^Report  of  the  Commissioner  of  Corporations  on  Water  Power  De- 
velopment in  the  United  States,  March  14,  1912)  pp.  37-47. 

See  also  Electrical  World,  January  1,  1921.  vol.  Ixxvii  for  the  esti- 
mate of  the  expansion  in  the  industry  up  to  1925.  Estimated  output  of 
Central  Power  stations  for  1920,  46,700,000,000  kilowatt  hours.  Estimated 
for  1925,  76,250,000,000. 

407 


408  INVESTMENT  ANALYSIS 

built.  As  early  as  1884,  Portland,  Oregon,  installed  the  first 
lighting  system  run  by  water-power,  which  was  obtained  from 
the  Williamette  River  thirteen  miles  distant.  This  was  neces- 
sarily very  small  because  of  the  limitation  in  voltage  that  could 
be  carried.  With  the  installation  of  the  alternating  current  in 
1888  at  the  Portland  power  plant,  which  marked  the  establish- 
ment of  the  first  long-distance,  high-voltage  plant,  the  voltage 
capacity  was  greatly  increased.  And  it  is  in  central  stations 
that  hydro-electric  power-plants  have  had  their  important 
growth  since  1900. 

The  development  prior  to  1893  was  limited  by  the  lack  of 
what  is  known  as  a  rotary  transformer,  which  transforms  an 
alternating  current  into  a  direct  current,  and  is  necessary  in 
transmitting  electricity  from  a  large  central  station.  Inventions 
and  improvements  have  followed  since  this  date  in  rapid  succes- 
sion, and  increased  the  marketing  area  of  the  average  power 
plant  to  no  less  than  100,000  square  miles.  The  longest  trans- 
mission now  possible  is  approximately  250  miles.  This  distance 
is  not  possible,  however,  with  all  plants. 

According  to  the  survey  of  the  former  Bureau  of  Corpora- 
tions the  developed  water-power  of  the  United  States  is  about 
one-fourth  of  the  minimum  and  one-seventh  of  the  maximum 
estimated  potential  water-power  of  this  country  (potential 
horse-power  being  based  on  75  per  cent  efficiency).  Other  esti- 
mates made  by  private  authority  place  the  available  supply  in 
the  United  States  at  37,000,000  h.  p.,  of  which  less  than  2,000,- 
000  h.  p.  has  been  developed.  The  New  England  states,  accord- 
ing to  the  Bureau  of  Corporations,  have  36  per  cent  of  their 
power  developed  and  owned  by  manufacturers;  New  York,  30 
per  cent ;  and  Minnesota  and  "Wisconsin  17  per  cent  in  concerns 
having  more  than  1,000  horse-power.  Of  the  estimated  poten- 
tial water-power  in  the  United  States  a  very  large  amount  is 
centralized  in  the  Western  states.  Figured  on  the  basis  of  75 
per  cent  efficiency,  43  per  cent  of  the  estimated  minimum  power 
of  the  country  is  found  in  the  states  of  California,  Oregon,  and 
Washington.  If  the  states  of  Montana,  Idaho,  Wyoming,  Colo- 
rado, Arizona,  and  Utah  were  added  to  these  Pacific  Coast 
states,  the  amount  would  be  70  per  cent.  The  states  to  the  north 


HYDRO-ELECTRIC  BONDS  409 

and  east  of  Pennsylvania  have  about  8  per  cent  and  the  states 
south  of  the  Ohio  and  east  of  the  Mississippi,  about  12  per  cent 
of  the  total  for  the  entire  country.1  These  three  groups  contain 
about  90  per  cent  of  the  total  minimum  potential  power  now 
available  in  the  United  States.  If  California,  Oregon,  Wash- 
ington, and  Idaho,  which  have  developed  less  than  7  per  cent 
of  their  capacity,  should  double  their  capacity  each  ten  years, 
it  would  take  forty  years  before  the  minimum  potential  power 
of  these  states  would  be  reached.  One  California  engineer  has 
estimated  that  if  25  per  cent  of  the  power  in  California  were 
developed,  it  would  eliminate  the  use  of  all  present  forms  of 
fuel  in  that  state.  "Experience,"  states  a  Bureau  of  Cor- 
porations Report,  "does  not  make  it  probable  that  the  actual 
development  will  be  as  rapid  as  this."  The  development,  how- 
ever, of  this  water-power  must  have  a  considerable  influence  on 
the  future  power-plant  and  upon  the  prices  of  power,  as  the 
power  supply  is  so  much  centralized,  and  the  possible  distance 
of  the  transmission  of  electricity  is  increasing. 

Character  of  Business  and  the  Market. — With  the  advent  of 
long  distance  electrical  transmission  devices  the  water-power 
industry  has  become  a  great  commercial  enterprise.  Where  it 
was  formerly  necessary  that  factories  desiring  to  purchase 
power  should  be  located  in  the  vicinity  of  a  large  city  it  is  no 
longer  essential  to  be  in  an  urban  vicinity  except  for  other 
reasons.  On  the  other  hand,  if  the  manufacturer  desired  to 
create  his  own  water-power,  it  was  necessary  to  be  in  the  imme- 
diate vicinity  of  this  power  supply.  Now,  raw  materials,  trans- 
portation facilities,  labor,  and  markets  may  all,  or  any  one  of 
them,  be  controlling  factors  in  the  determination  of  location. 
With  the  still  further  improvement  of  devices  for  the  trans- 
mission of  electricity,  water-power  will  assume  large  importance 
in  the  manufacturing  field.  Water-power  must  also  ultimately 
supersede  steam-power  in  many  localities  for  manufacturing 
purposes,  where  it  is  as  yet  little  developed.  For  the  investor 
of  today,  this  is,  however,  looking  too  far  in  the  future,  except 
in  very  particular  instances. 


*Report  of  the  Commissioners  of  Corporations  on  Water-power  De- 
velopment in  the  United  States,  pp.  37-47. 


410  INVESTMENT  ANALYSIS 

The  growth  in  the  use  of  electric-power  is  in  itself  phenom- 
enal. The  increasing  demand  for  the  services  of  public  utili- 
ties together  with  the  growth  in  urban  population  is  con- 
stantly increasing  the  demand  for  electrical  current.  The  use 
of  electrical  power  by  railroads  will  no  doubt  eventually  be 
adopted  within  all  large  urban  boundaries.  Other  railroads  will 
also,  sooner  or  later,  follow  the  policy  of  the  Chicago  Milwau- 
kee and  St.  Paul  Railway  in  the  electrification  of  its  system 
over  the  mountains  where  sufficient  power  is  accessible.  Com- 
mercial and  office  buildings  are  being  electrically  equipped  as 
well  as  lighted  by  electricity.  Electrical  power  is  also  more  than 
ever  used  in  mines,  quarries,  and  industries  where  portable 
power  is  required.  In  small  industries  where  intermittent 
power  is  needed,  the  convenience  and  cheapness  of  electrical 
power  is  now  acknowledged.  The  increasing  use  of  electricity  in 
household  devices  is  also  developing  a  profitable  source  of  in- 
come. The  installation  of  electrical  devices  in  homes  has  come 
into  popularity  since  the  increase  in  domestic  wages  in  1916. 
Once  these  electrical  household  utilities  are  instituted,  their  use 
will  become  permanent. 

The  cheap  operating  costs  of  large  hydro-electric  plants  will 
often  enable  them  to  induce  enterprises  which  have  generated 
their  own  power  in  the  past,  to  abandon  their  equipment  for 
power  generation  and  connect  with  the  transmission  wires  of 
the  hydro-electric  companies.  And  it  is  questionable  whether  a 
public  utility  in  the  vicinity  of  a  large  hydro-electric  plant 
which  controls  all  the  available  power  supply,  can  afford  to  gen- 
erate its  own  power.  The  use  of  hydro-electric  power  by  the 
Northwest  public  utilities,  mines,  and  lumbering  interests  and 
in  the  Niagara  Falls  territory  is  demonstrating  the  lower  cost 
of  power  from  hydro-electric  power  plants  where  water  is  easily 
accessible.  Where  the  same  interest  controls  both  the  power- 
plant  and  the  industry,  a  market  for  a  portion  of  the  water- 
power  is  assured.  If  these  industries,  as  is  generally  the  case, 
are  mines,  quarries,  lumbering,  etc.,  and  they  furnish  the  larger 
part  of  the  income,  the  hydro-electric  plant  will  suffer  severe 
reaction  when  these  industries  are  exhausted.  Sufficient  diver- 
sity should  be  used  in  the  consumption  of  electrical  current,  to 


HYDRO-ELECTRIC  BONDS  411 

safeguard  a  company;  against  any  such  contingency.  The  best 
insurance  against  this  is  a  very  wide  diversity  of  the  market. 
Some  of  these  companies  have  fortified  themselves  still  more  by 
obtaining  direct  control  of  a  large  company  or  group  of  com- 
panies. 

Competition. — The  important  point  in  the  study  of  both  the 
developed  and  undeveloped  water-power  area,  as  far  as  the  in- 
vestment in  a  particular  property  is  concerned,  is  to  ascertain 
the  character  of  the  water  supply  and  the  possible  development 
of  water-power  competition  in  the  same  locality.  Subsequent 
irrigation  reserves  or  power-plants,  which  will  utilize  all  the 
sources  of  water  supply  without  violating  any  of  the  water- 
rights  of  the  established  power  plant,  may  be  developed  in  the 
same  territory  occupied  by  an  existing  power-plant.  The  con- 
tracts for  the  sale  of  power  are  usually  for  short  terms.  This 
makes  it  quite  possible  for  competing  companies  enjoying  any 
peculiar  advantages  to  bid  for  these  contracts  at  lower  figures. 
Even  if  franchises  are  exclusive,  too  much  dependence  must  not 
be  placed  on  their  inviolability  until  they  have  been  tried  in  the 
highest  court,  as  new  companies  may  be  legalized  and  competi- 
tion instituted. 

A  sufficient  number  of  the  contracts  for  selling  power  should 
extend  beyond  the  life  of  the  bonds  to  insure  the  fixed  charges. 
On  the  other  hand,  where  demand  for  power  is  growing  very 
rapidly,  profits  would  be  curtailed  considerably,  if  the  company 
were  rigidly  tied  up  in  long-time,  low-priced  contracts.  Com- 
panies at  their  inception  have,  however,  often  been  forced  to 
accept  low  prices  to  their  later  disadvantage.  This,  of  itself, 
where  other  water-power  is  available  might  induce  competition. 
Where  a  territory  is  developing  commercially  and  industrially, 
it  is  of  extreme  advantage  to  have  short-termed  contracts  for 
everything  above  the  amount  needed  to  insure  the  fixed  charges. 
Where  too  large  an  amount  of  the  income  is  derived  from  one 
or  two  sources  and  especially  where  other  sources  of  income  are 
limited,  the  character  of  the  contract  becomes  all-important,  as 
competing  power-plants  might  even  be  able  to  pay  drainage 
charges  and  offer  more  favorable  terms.  The  competition  of 
steam  may  also  become  vital  to  a  power-plant,  if  coal  can  be 


412  INVESTMENT  ANALYSIS 

obtained  at  an  advantage  in  the  locality.  If  industries  which 
use  either  steam  or  heat,  or  both,  are  located  or  are  likely  to  be 
developed  in  the  area  of  the  power-plant,  the  demand  for  manu- 
facturing power  may  be  greatly  limited.  If  the  power  contracts 
are  large,  the  power  company  may  profitably  establish  steam 
auxiliary  plants  to  supply  the  need  and  thus  avoid  possible 
competition  from  this  source. 

Where  steam  must  be  introduced  as  auxiliary  power  to 
provide  for  certain  periods  of  low  water  supply,  the  increased 
costs  accrued  may  enable  other  power-plants  having  sufficient 
water  to  compete.  This  will  be  especially  true  if  there  is  too 
wide  a  variation  between  the  amount  of  power  that  can  be 
furnished  at  the  low  and  high  water  mark.  If  this  variation 
is  large,,  the  power  company  is  compelled  to  place  too  large  an 
investment  in  auxiliary  steamplants,  and  this  will  greatly  in- 
crease the  cost  of  the  output.  Because  of  the  great  efficiency 
obtained  by  water-wheels  with  the  utilization  of  70  to  80  per 
cent  of  the  theoretical  energy  of  falling  water  and  the  small 
loss  in  transmission  of  current,  as  against  15  per  cent  theoretical 
energy  obtained  from  coal  and  21  per  cent  in  gas  engines,  there 
is  a  much  greater  possibility  of  increase  in  efficiency  in  the 
last  two.1  While  great  increase  in  efficiency  has  been  shown  in 
steam-plants  in  the  last  decade,  water-power  under  favorable 
conditions  can  be  produced  at  lower  costs,  provided  the  original 
dam  and  power-plant  costs  are  not  too  great.2  And  if,  in  addi- 
tion to  this,  operating  costs  are  low,  and  a  small  amount  of 
current  capital  is  needed,  the  first  essentials  for  a  financially 
strong  water  company  exist. 

A  brief  of  the  American  Institute  of  Electrical  Engineers 
states : 

"Practically  all  water-powers  come  to  birth  or  not,  on  the 
answer  to  the  question,  'what  is  the  steam-power  in  the  terri- 
tory costing?'  and  they  can  only  live  when  they  deliver  power 
at  substantially  lower  cost.  At  the  same  cost  they  remain 
unborn. 

"Besides  the  cost  of  power,  the  relative  amount  of  invest- 

'George  Fillmore  Swain,  Conservation  of  Water  Storage  (1915), 
p.  239. 


HYDRO-ELECTRIC  BONDS  413 

ment  is  a  determining  factor.  While  at  present  a  steam  electric 
plant  can  be  built  for  $75  per  horse-power,  the  cost  of  a  hydro- 
electric plant  varies  from  two  to  four  times  that  amount.  Part 
of  this  difference  is  because  the  steam-plant  can  be  built  near 
the  center  of  its  market,  while  the  power-plant  is  invariably  at 
a  distance. 

"With  the  capital  required  for  a  water-power  so  much 
greater,  the  tendency  is  to  build  a  steam-plant,  even  if  the  power 
it  delivers  is  not  as  cheap  as  that  of  water-power.  If  it  can  be 
shown  that  water-power  can  be  delivered  for  say  $25  per  horse- 
power per  year,  but  that  steam  can  be  produced  for,  say,  $27, 
the  water-power  plant  will  not  be  built  and  the  steam-power 
will.  If,  however,  the  water-power  could  be  delivered  for  $24, 
the  difference  might  turn  the  tide  in  favor  of  the  hydro-electric 
investment.  It  is  this  slight  variation  in  the  charges  against 
taxes,  sinking  funds  etc.,"  further  states  this  commission, 
''which  makes  these  differences  loom  so  large." 

Water  Supply,  Storage,  and  Pondage. — "The  possibility," 
states  Walter  McCulloch,  "of  every  project  for  the  conserva- 
tion of  water  must  be  determined  upon  economic,  hydrographic, 
topographic,  and  geologic  data :  the  economic  to  determine  the 
necessity  for  steam-power  regulation  by  the  storage  of  its  sur- 
plus waters;  the  hydrographic,  the  amount  of  water  to  be  con- 
trolled under  material  conditions  and  what  may  be  effected  by 
such  control;  the  topographic,  to  determine  the  nature  and 
extent  of  the  watershed  and  the  location  and  availability  of 
reservoir  sites  for  water  storage  and  the  geologic  to  determine 
the  practicability  and  safety  of  the  sites  selected  for  reservoir 
dams,  embankments  and  other  structures  appurtenant  thereto. 
Without  such  data,  no  water  storage  study  can  be  made  com- 
plete, and  the  value  of  the  conclusion  arrived  at  would  be 
directly  proportional  to  the  accuracy  of  the  data  upon  which 
the  whole  investigation  rests." 

The  economic  necessity  of  storage  of  water  depends  upon 
the  amount  of  the  regular  recurrence  of  the  source  of  water.  If 
the  supply  is  irregular  or  fluctuates  with  seasonal  changes,  two 
different  kinds  of  storage  problems  are  confronted;  the  daily 


*A  brief  prepared  by  the  Public  Policy  Committee  and  Advisory 
Members  of  the  American  Institute  of  Electrical  Engineers  and  pre- 
sented at  the  public  hearing  before  the  United  States  National  Water- 
ways Commission,  Washington.  D.  C.,  November  21,  1911. 

'Walter  McCulloch,  Conservation  of  Water  (In  the  Chester  S.  Lyman 
Lecture  Series,  1912.  before  the  Senior  Class  of  the  Sheffield  Scien- 
tific School,  Yale  Univ.,  p.  13). 


INVESTMENT  ANALYSIS 

and  the  seasonal.  "Where  there  is  a  very  wide  difference  be- 
tween the  seasonal  maximum  and  minimum  flow  of  a  stream, 
pondage  or  storage  is  necessary.  In  this  case  the  value  of  the 
water-power  will  be  determined  by  the  cost  of  construction  as 
compared  to  the  advantages  of  the  utilization  of  steam  and  the 
market  for  the  current.  A  large  supply  of  water  might  be 
secured  but  the  character  of  the  accessible  industries  which 
could  use  the  current  would  not  warrant  the  large  expenditures 
to  secure  the  supply.  Proper  economies  used  in  the  impound- 
ing of  the  water  itself  also  often  determine  whether  the  enter- 
prise will  be  profitable.  A  correct  retention  of  water  during 
the  rainy  season  may  so  increase  the  rates  of  flow  during  the 
dry  season  that  steam  auxiliaries  are  not  essential. 

The  flow  of  water  in  a  stream  is  dependent  upon  the  inten- 
sity, distribution,  and  amount  per  annum  of  rainfall,  the 
topographical  features,  character  and  size  of  the  drainage  area, 
fluctuation  of  temperature,  rapidity  of  evaporation,  character 
and  density  of  vegetation,  and  soil  characteristics  that  affect  the 
un-off.1  The  existence  of  large  bodies  of  water  does  not  neces- 
sarily indicate  a  large  supply  of  water  for  power  flow,  as  evap- 
oration may  take  place  as  fast  as  the  water  enters  from  feeding 
streams.  With  so  many  factors  affecting  the  character  of  the 
water  supply,  the  danger  in  assembling  hasty  and  short  dura- 
tion data  is  obvious.2  Engineers  have  made  examination  of 
proposed  power-sites  and  on  the  basis  of  two  or  three  months' 
rainfall  estimated  the  probable  water  supply.  The  result  has 
often  spelled  failure.  Rains  vary  with  the  season  and  from 
year  to  year,  in  a  ratio  of  20  to  100  and  even  more.  No  com- 
putation estimating  the  minimum  amount  would  be  safe  without 
data  covering  a  long  period.  A  good  illustration  of  the  errors 
which  may  be  experienced  in  taking  too  short  records  was 
demonstrated  in  the  case  of  the  Conconully  reservoir  in  Wash- 


*The  HydrograpMc  Manual  of  the  United  States  Geological  Survey 
Papers  No.  94 ;  other  Water  Supply  Papers  give  a  complete  description  of 
how  run-offs  are  obtained. 

'George  Fillmore  Swain  cites  an  interesting  example  of  a  variation 
between  his  own  experience  and  the  estimates  of  two  other  prominent 
engineers  on  the  flow  of  the  Merrimac  at  Lawrence,  Massachusetts. 
(G.  F.  Swain,  Ibid.,  p.  179.) 


HYDRO-ELECTRIC  BONDS  415 

ington,  in  which  the  records  for  five  years  indicated  a  minimum 
annual  supply  of  29,000  acre  feet,  which  two  years  later  showed 
19,220  and  15,860  acre  feet  respectively.  An  average  rain- 
fall at  the  source  of  a.  stream  at  one  season  of  the  year  may 
create  a  very  strong  flow  through  an  arid  or  semi-arid  region, 
but  at  another  period  the  rapid  evaporation  will  largely  con- 
sume the  water  supply. 

Topography  and  geological  formation  may  cause  such  a 
rapid  running  off  of  the  water  during  seasons  that  the  cost  of 
securing  the  water  is  increased  many  fold.1  On  the  other 
hand,  if  the  drainage  area  has  a  consistently  regular  source,  it 
makes  possible  the  operation  of  plants  which,  if  dependent  on 
summer  streams,  would  often  be  forced  to  close.  Further  to 
insure  an  adequate  water  supply,  not  only  the  sources  of  supply 
but  also  a  large  drainage  area  should  be  controlled.  Past  rec- 
ords of  supply  may  be  good,  but  what  may  happen  to  this 
source  of  supply  without  a  very  large  control  of  sources  is  an- 
other question.  Denuding  our  mountains  and  hills  of  their 
forests  has  dried  up  certain  former  sources  of  water  supply. 
Mountain  snows,  while  they  furnish  an  excellent  supply  of 
water,  are  not  always  dependable  for  a  continuous  supply  as  has 
been  experienced  in  the  flow  of  Rocky  Mountain  streams. 
Where  the  area  of  supply  is  small,  there  is  greater  danger  of 
depletion,  especially  if  a  competing  concern  can  divert  water 
for  other  purposes  without  violating  riparian  rights.  To  in- 
sure a  company's  water  supply  against  these  possible  exigencies 
and  thus  from  exhaustion,  demands  the  control  of  a  very  large 
drainage  area. 

After  a  survey  of  the  sources  of  water  assures  a  sufficient 
supply,  the  possibilities  and  cost  of  constructing  storage  facili- 
ties must  be  considered.  If  a  natural  lake  or  basin  exists 
for  the  making  of  a  lake-reservoir,  construction  costs  may  be 
small,  but  in  some  cases  the  work  of  securing  a  safe  discharge 
of  the  flood  waters  of  the  stream  in  natural  basins  is  expensive 
in  proportion  to  the  capacity  obtained.  Also,  these  natural 

'Daniel  W.  Mead,  Water-poicer  Engineering  (1908),  pp.  79-195.  Also 
see  Eric  A.  Lof,  David  R.  Rushmore,  Hydro-Electric  Stations  (1917), 
chaps,  i  and  ii. 


416  INVESTMENT  ANALYSIS 

basins  or  dried  up  lake  beds,  may  allow  enormous  wastes  in 
seepage  and  subterranean  outlets,  and  may  therefore  be  un- 
serviceable. The  Deer  Fleet  Keservoir  near  Boise,  Idaho,  in 
1909  was  filled  with  about  60,000  acre  feet  of  water  when  com- 
pleted, the  greater  part  of  which  was  lost  by  seepage.  It  is  also 
necessary  that  the  rocks  or  soils  be  able  to  retain  the  founda- 
tion of  dam  construction.  The  necessity  of  going  to  any  great 
depth  to  obtain  a  solid  foundation  for  the  reservoir  walls  rap- 
idly forces  up  the  cost  of  construction.  With  the  enormous 
initial  outlays  which  must  be  made  in  securing  a  sufficient  and 
uninterrupted  water  supply,  it  is  readily  seen  how  important 
become  the  conditions  affecting  this  supply  and  the  costs  of 
retaining  it.1 

When  water  supply  and  construction  costs  have  been  se- 
cured, are  they  warranted  on  the  basis  of  the  existing  or  poten- 
tial market  for  electric  current?  As  this  has  been  referred 
to  under  a  previous  topic,  the  reader  is  here  only  again  re- 
minded of  its  importance. 

Riparian  Rights. — The  law  of  riparian  rights  is  still  in  a 
formative  state  and  considerable  variation  exists  between  the 
statutes  of  the  various  states.  Courts,  also,  have  differed  con- 
siderably in  the  interpretation  of  these  statutes.  Consciously  or 
unconsciously,  the  courts  have  been  influenced  by  the  location 
of  the  water  supply,  i.  e.,  whether  in  a  humid  or  arid  region. 
For  example,  the  western  part  of  the  state  of  Washington, 
which  is  humid,  has  had  several  decisions  varying  from  those 
of  the  arid  eastern  section  of  the  state.  The  same  originally 
was  true  of  the  decisions  of  the  California  Courts.  The  doc- 
trine of  "appropriation  of  use"  which  has  been  widely  adopted 
by  the  western  arid  states  is  in  direct  opposition  to  the  statutes 
and  court  decisions  of  the  humid  states  of  the  East,  which  hold 
to  the  old  English  practice  that  each  landed  proprietor  must 
permit  the  flow  of  a  stream  bordering  his  land  to  continue  un- 
abated in  either  quality  or  quantity. 

There  have  been,   consequently,   innumerable  controversies 


*J.  T.  Johnson  has  given  a  very  satisfactory  guide  for  the  collection 
and  compiling  of  reports  and  field  data  for  electric  power  companies  in 
the  Annual  Report  for  1914  of  the  Water-power  Department  (Canada). 


HYDRO-ELECTRIC  BONDS  417 

and  court  decisions  have  frequently  conflicted.  This  situation 
has  not  only  involved  a  number  of  projects  in  large  legal  ex- 
penses, but  has  placed  their  securities  in  a  doubtful,  and  not 
infrequently,  a  precarious  position.  While  the  laws  are  rap- 
idly becoming  more  uniform  and  established  by  court  decisions, 
the  importance  of  water-rights  enters  to  a  large  measure,  in  an 
analysis  of  the  security,  not  only  of  hydro-electric  but  also  of 
water  company1  and  irrigation  bonds.2  A  brief  statement,  conse- 
quently, of  riparian  rights  in  the  arid  states  might  be  of  value. 

There  are  in  existence  now  in  the  western  states,  three  dis- 
tinct doctrines  of  riparian  rights.  A  very  small  acreage  in 
nearly  all  of  the  states  uses  water  under  the  old  common  law 
doctrine.  In  the  states  created  out  of  the  acquisition  from 
Mexico,  another  small  acreage  uses  water  under  the  old  Spanish 
and  Mexican  grants.  The  great  majority  of  irrigated  farms  are 
being  watered  under  the  "appropriation  and  use"  of  riparian 
rights;  i.e.,  all  water  may  be  put  to  any  beneficial  use  under 
the  regulation  of  the  state. 

The  manner  of  the  acquisition  of  water  rights  under  these 
statutes  is  extremely  variable.  In  Arizona,  California,  Kansas, 
Montana  and  Washington,  the  only  requirement  is  the  posting 
of  a  notice  at  the  point  of  diversion  stating  the  amount  of  water 
to  be  taken.  The  chief  difficulty  here  arises  in  valuing  the 
record,  as  the  only  records  available  are  those  of  the  individual 
counties  and  these  are  incomplete.  If  prior  appropriations 
experience  a  shortage  of  water,  later  appropriations  must  take 
what  is  left.  This  brings  the  matter  into  the  courts.  The  suit 
is  usually  a  long  drawn-out  process,  as  most  states  now  require 
that  the  suit  include  all  parties  affected  by  the  same  water 
supply.  One  case  has  been  reported  to  have  included  nearly 
four  thousand  individuals. 

All  states  except  Colorado3  require  that  the  appropriator 
obtain  a  permit  from  the  state.  This  is  commonly  called  the 
Wyoming  system,*  which  has  been  largely  copied  by  the  other 

'Chap,  xxiii. 

*Chap.  xxxi. 

"Colorado  was  the  first  state  to  adopt  laws  regulating  irrigation. 

4Law  drafted  by  Dr.  Elwood  Mead. 


418  INVESTMENT  ANALYSIS 

states.  Though  Colorado  does  not  require  a  permit,  it  does 
require  that  construction  shall  begin  within  a  stated  period. 
Nebraska,  Nevada,  Texas  and  Wyoming  are  the  only  states  hav- 
ing administration  boards  to  determine  specifically  what  these 
rights  are.  In  the  other  states,  if  a  right  is  disputed,  it  must  be 
adjusted  by  the  courts.  This  has  resulted  in  many  complications, 
and  these  difficulties  must  continue  to  exist  as  long  as  it  is  so 
easy  to  destroy  priority.  It  is  estimated  that  more  than  50  per 
cent  of  the  water  rights  in  the  United  States,  though  considered 
valid,  have  not  been  adjudicated.  "On  the  other  hand,"  states 
Mr.  Samuel  Fortier,  "the  fact  that  the  right  has  been  adjudi- 
cated or  defined  is  not  an  absolute  guarantee  of  the  extent  or 
value  of  the  right,  as  the  appropriator  may  be  entitled  only  in 
time  of  flood,  only  when  the  flow  is  considerably  above  the  low 
summer  stage,  or  only  at  certain  periods  of  the  year;  the  right 
may  have  been  adjudicated  as  against  only  part  of  the  other 
claims  from  the  same  source  of  supply." 

Public  Regulation  of  Water-Power.* — Until  very  recent 
years,  all  water-power  regulation  has  been  based  on  private 
rights  and  public  safety,  and  not  on  specific  statutes  established 
on  economic  grounds.  But  the  development  of  water-power  has 
led  to  some  important  legislation  affecting  its  regulation.  The 
enabling  acts  and  many  state  constitutions  of  the  Mississippi 
Valley  and  Pacific  Coast  states  make  all  navigable  streams 
public  highways,  consequently  public3  property.  In  many  of 
the  interior  states,  however,  which  have  adopted  the  distinction 
of  the  English  law,  non-navigable  streams  above  tide  are  con- 
sidered as  private  property  and  belong  to  the  riparian  owner. 
The  Atlantic  Seaboard  states  have  also  followed  the  English 
interpretation  with  important  modifications.4 


'Samuel  Fortier,  Use  of  Water  in  Irrigation  (1916) ,  p.  18. 

This  topic  should  be  closely  studied  with  the  topic  on  Riparian 
Rights. 

3The  two  following  references  will  give  the  reader  a  good  view  of 
this  problem:  Rome  G.  Brown.  Limitations  of  Federal  Control  of 
Water-power;  John  A.  Fairlie.  Public  Regulation  of  Water-power  in  the 
United  States  and  Europe,  Michigan  Law  Review,  vol.  ix,  No.  6  (Apr., 
1911). 

4The  law  of  prior  appropriation  called  the  Colorado  doctrine,  is  in 
force  in  Arizona,  Colorado,  Idaho,  New  Mexico,  Nevada,  Utah,  and 
Wyoming. 


HYDRO-ELECTRIC  BONDS  419 

The  difficulty  with  water-power  companies  has  arisen  over 
the  confusion  of  what  constitutes  a  navigable  stream.  For 
example,  the  Economy  Light  and  Power  Company  of  Illinois, 
which  was  prevented  from  even  starting  a  newly  constructed 
plant,  claimed  title  to  the  river  bed  of  the  Des  Plaines  River 
as  a  riparian  owner,  and  by  grants  given  by  the  Canal 
Commission.  The  company's  claims  were  sustained  by  the 
Supreme  Court  of  the  state1  but  the  United  States  Federal 
Supreme  Court  in  1921  rendered  a  decision  against  the 
company.  While  riparian  owners,  as  power-companies,  have 
rights  even  in  navigable  streams,  they  are  limited  by  Federal 
and  state  laws  purporting  to  represent  public  interests.  The 
United  States  Supreme  Court  in  several  important  decisions 
has  very  definitely  stated  that,  where  a  river  is  wholly  within 
the  boundaries  of  a  state,  that  state  has  complete  plenary 
powers2  and  "what  it  has  it  may  keep  and  give  no  reason  for 
its  will."  The  state  authority,  together  with  the  control  exer- 
cised by  the  United  States  over  navigable  streams,3  has,  unless 
the  titles  of  power-rights  are  quite  definitely  established  before 
the  installation  of  the  plant,  caused  large  losses  in  many  long 
drawn-out  litigations. 

"Where  large  sums  are  put  in  fixed  property  accounts,  the 
proposed  ten-year  franchise  for  power-rights  is  too  precarious 
for  any  investor  to  consider,  unless  there  is  a  very  definite 
clause  in  the  franchise  stating  that  a  renewal  will  be  permitted 
or  the  company  will  be  compensated  for  the  full  value  of  the 
plant.  If  the  franchise  can  be  renewed,  the  possibility  of  a 
change  in  the  taxation  and  a  lowering  of  the  rates  of  the  com- 
pany should  be  discounted  by  the  investor  in  order  that  the 
total  average  income  from  the  investment  may  be  calculated. 
While  conservation  propaganda  should  be  carried  forward, 
many  of  the  unscientific  schemes  proposed  for  regulating  water- 
power  rights  would  bring  untold  injury  to  the  power-plants 
working  under  the  burden  of  the  larger  outlays.  Inelastic  regu- 
lation must  make  the  company  with  a  $700  outlay  per  horse- 


vs.  Economy  Lisht  and  Power  Company,  241  111.  200. 
'North  Shore  Driving  Col.  vs.  Nieonian  Boom,  212  U.  S.  406,  1909. 
"Act  of  Congress,  June  21,  1906. 


420  INVESTMENT  ANALYSIS 

power  bear  an  unwarranted  financial  burden  in  comparison 
with  the  company  on  whom  the  same  obligation  is  placed  but 
whose  cost  is  only  $75  per  horse-power.  Fortunately,  the  greater 
part  of  the  largest  companies  come  entirely  under  the  control 
of  the  Federal  Government;  consequently,  they  are  not  subject 
to  the  jurisdiction  of  state  commissions.  This  also  gives  them 
greater  rights  in  franchise  privileges. 

Construction  Costs. — As  with  all  public  utility  construction 
costs,  no  standard  can  be  fixed.  Costs  with  equally  successful 
records  have  varied  from  less  than  $50  to  $1,000  per  horse- 
power. For  illustration,  the  Chicago  Drainage  Canal,  Lock- 
port,  was  built  at  a  cost  of  $252.80  per  horse-power,1  the  plant 
at  Columbus,  Georgia,  at  $50,2  and  that  at  Winnepeg,  Manitoba, 
at  $156.  The  Ontario  Hydro-Electric  Power  Commission 
showed  estimates  for  seventeen  different  power-plants  in  Ontario 
on  the  same  stream  with  a  variation  from  $61  to  $203  per  horse- 
power. As  a  rule,  other  conditions  being  equal,  the  larger 
plants  are  built  at  a  smaller  unit  cost  than  smaller  plants. 
Geographical  and  climatic  conditions  affecting  the  source  of  the 
water  supply  vary  greatly.  Obstacles  to  the  construction  of  a 
solid  foundation  for  dams — such  as  the  protection  of  the  loca- 
tion of  the  power-house  from  floods,  ice,  destructive  shalings, 
and  slides  which  require  expensive  excavation — vary  with  every 
project  and  are  responsible  for  the  differences  in  dam  and 
power-house  construction  costs.  The  erection  of  transmission 
wires  and  transforming  stations,  if  the  power-plant  is  greatly 
removed  from  the  market,  may  also  become  costly  items  in 
construction  costs.  Even  where  the  dam  and  power-house  costs 
are  reasonably  low,  costly  long  distance  transmission  wires  may 
more  than  offset  the  advantages  of  the  former. 

With  these  difficult  problems  in  construction  involved,  the 
care  necessary  in  the  examination  of  construction  costs  of  new 
projects  needs  no  emphasis.  The  surest  safeguard  is  an  experi- 
enced and  reputable  firm  of  engineers.  Most  of  the  serious 
losses  from  faulty  construction,  in  the  past,  have  been  the  result 


^Electrical  World,  vol.  xlvii  (1906),  p.  398. 

'Electrical  World  and  Engineer,  vol.  xliii  (1904),  p.  165. 


HYDRO-ELECTRIC  BONDS  421 

of  the  errors  of  experienced  engineers  with  a  lack  of  professional 
conservatism.  Cognizance  must  then  certainly  first  be  taken 
of  the  character  of  the  engineering  firm  employed,  even  if  the 
engineering  reports  are  carefully  scrutinized.  The  most  posi- 
tive evidence  obtainable  of  the  accuracy  of  the  engineering 
report,  is  the  record  of  the  correctness  of  the  firm's  previous 
judgments.  Faulty  judgment  upon  the  initial  outlay  necessary 
for  installation  has  often  been  sufficient  to  cause  the  failure  of  a 
project.  When  the  fund  raised  for  the  construction  of  a  new 
plant  has  been  exhausted  without  the  completion  of  the  plant, 
it  is  extremely  difficult  to  obtain  additional  funds.  The  author 
has  in  mind  a  hydro-electric  plant  the  construction  cost  of  which 
the  engineer  had  largely  underestimated  because  of  the  unfore- 
seen difficulty  in  the  construction  of  the  dam  on  account  of 
peculiar  geological  formations.  The  practice  followed  in  some 
hydro-electric  bond  issues  has  been  to  include  in  the  mortgage 
a  limitation  clause  that  will  prevent  the  issue  of  more  bonds. 
If  an  unforeseen  condition  should  arise  or  the  estimates  prove 
in  error,  the  difficulty  in  securing  additional  funds  to  com- 
plete the  project  would  be  greatly  increased,  though,  as  stated 
later,  such  a  limitation  clause  ordinarily  strengthens  the  secu- 
rity of  these  bonds. 

Over-estimating  the  future  has  been  a  common  fault  with 
hydro-electric  projects,  as  with  irrigation  companies,  both  of 
which  are  compelled  to  build  for  the  future  more  largely  than 
any  other  public  utility.  It  is  quite  essential,  that  where  the 
permanent  outlay  is  so  large,  construction  must  anticipate  the 
future  demand  for  several  years  to  come,  but  building  for  a 
too  distant  future  incurs  a  fixed  charge  for  the  present  that 
is  too  large  to  carry  on  the  basis  of  existing  earnings.  If  a 
slump  in  industries  also  takes  place,  as  from  1911  to  1915, 
the  burden  upon  these  companies  will  be  greatly  aggravated. 
There  is  little  question  but  that  several  hydro-electric  power 
companies  would  have  passed  into  receivership  had  not  the 
European  war  occurred  at  the  time  it  did.  The  tremendous 
demand  which  sprang  up,  almost  over  night,  from  our  Allies 
for  all  forms  of  mineral  products  created  a  capacity  demand 
for  power.  As  a  general  rule  past  experience  has  demonstrated 


422  INVESTMENT  ANALYSIS 

the  advisability  of  discounting  the   estimated  prospects  of  a 
new  enterprise  not  yet  constructed. 

In  determining  the  amount  of  water  supply,  one  thing 
already  brought  to  the  attention  of  the  reader  is  the  necessity 
of  constructing  auxiliary  steam-power  where  the  water  supply 
is  not  sufficient  or  is  intermittent.  If  this  is  necessary,  it  means 
a  very  considerable  increase  in  the  amount  of  construction, 
which  increases  the  costs  of  construction  and  also  of  operation. 
Again  in  new  enterprises,  if  the  estimates  show  the  immediate 
necessity  or  even  the  eventual  need  of  constructing  auxiliary 
power-plants,  there  should  be  a  more  careful  checking  of  any 
reports  offered  upon  the  properties  than  where  the  power  is  to 
be  furnished  entirely  by  water.  If  steam  is  eventually  to  fur- 
nish a  large  part  of  the  power,  the  location  of  the  plant  may 
also  place  it  in  serious  competition,  as  already  suggested,  with 
steam-plants  more  favorably  located  near  the  market. 

Earnings  and  Operation  Costs.1 — For  the  technical  meas- 
urements and  analysis  of  earnings  and  costs  the  reader  is  re- 
ferred to  the  discussion  of  these  topics  under  Electric  Light 
and  Power  Bonds.  As  with  the  electric  light  companies,  the  con- 
tinuation of  earnings  of  hydro-electric  companies  depends  upon 
the  diversity  of  the  industries  within  the  power  area.  In  secur- 
ing the  use  of  electricity  by  existing  manufactures  and  induc- 
ing new  industries  to  locate  within  its  area,  the  hydro-electric 
company  has  the  same  problem  of  obtaining  a  diversification  for 
its  current  and  leveling  down  its  peak  load,  as  has  the  electric 
light  companies.2  In  addition  to  the  problem  of  the 
load  there  is  also  the  seasonal  demand,  which,  like  the 
demand,  is  usually  greater  in  the  winter  months  owing  to  the 
shorter  hours  of  sunlight  from  November  to  April.  Obviously, 
if  the  load  factor  in  one  company  is  60  per  cent  as  compared 
to  30  per  cent  in  another,  the  gross  income,  other  things  equal, 
should  be  correspondingly  greater  in  the  former.  And  it  is 
always  with  the  increase  of  this  load  factor  that  the  advantages 
of  the  hydro-electric  power  plants  are  increased  over  steam- 

'For  technical  units  of  measurement  see  previous  chapters  on  Public 
Utilities. 

2See  chap.  xxi. 


HYDRO-ELECTRIC  BONDS  423 

power.  This  is  because  of  the  large  ratio  of  fixed  investment  to 
operating  costs.  To  secure  the  largest  load,  however,  it  is  nec- 
essary that  the  uses  of  current  sold  be  distributed  throughout 
the  twenty-four  hours.  This  distribution  is  at  least  greatly  en- 
couraged by  giving  lower  rates. 

Where  both  size  and  diversity  in  the  market  for  current 
can  be  secured,  the  hydro-electric  power-company  has  a  very 
large  advantage  in  its  low  operating  ratio.  The  operating  ratio 
usually  has  an  average  range  from  20  to  40  per  cent.  And 
with  a  certainty  of  steadiness  of  income,  the  operating  ratio  is 
subject  to  little  fluctuation,  as  material  and  labor  costs  do  not 
effect  hydro-electric  power  companies  to  the  Scime  extent  as  they 
do  other  public  utilities.  With  conditions  assured,  hydro- 
electric companies  are  enabled  to  carry  safely  a  much  larger 
fixed  charge  than  other  companies. 

Market  and  Bond  Characteristics. — Water-power  bonds  are 
rapidly  gaining  a  wider  market,  though  they  are  still  narrowly 
held.  The  larger  development  of  this  industry  has  been  so 
recent  that  the  public  has  not  become  familiar  with  hydro- 
electric securities.  While  the  market  in  these  securities  will 
broaden,  it  will  never  become  very  active  or  speculative.  The 
industry  is  of  such  a  character  that,  if  conservative  and  reliable 
engineers  have  constructed  the  plant  and  made  the  estimates, 
fairly  accurate  valuations  can  be  placed  upon  the  properties, 
though,  as  already  pointed  out  errors  may  be  made  during  the 
period  of  construction.  Errors  are  also  more  likely  to  occur 
in  the  estimates  of  future  growth  than  in  the  immediate 
earning  power.  Water-power  projects,  however,  after  they  are 
once  established  and  seasoned,  are  without  question,  a  very  de- 
sirable form  of  security  for  the  conservative  investor. 

To  insure  this  stability,  it  is  assumed  that  a  sufficient  number 
of  contracts  are  on  hand  to  cover  the  life  of  the  bonds.  This 
should  be  demanded  in  a  new  enterprise,  though  in  a  rapidly 
growing  community  and  with  the  increasing  price  of  coal, 
renewal  privileges  would  be  advantageous. 

Because  of  the  narrow  market,  these  bonds,  except  those  of 
a  few  of  the  very  largest  companies,  are  not  always  readily  con- 
vertible, especially  in  a  strained  market.  But  where  well 


424  INVESTMENT  ANALYSIS 

selected,  they  do  not  usually  suffer  severe  relapses  in  market 
price.  While  these  bonds  would  not  meet  the  full  requirements 
of  a  business  surplus,  they  do  meet  all  the  requirements  of  a 
trust  estate  where  convertibility  is  not  demanded. 

Power-plant  bonds  are  now  practically  all  protected  by 
clauses  limiting  any  additional  issues  to  a  given  percentage  of 
actually  installed  extensions  or  additions.  This  sometimes, 
though  it  prevents  any  overburden  of  fixed  obligation,  is  elastic 
enough  to  meet  the  demands  for  protection,  at  the  same  time 
that  it  increases  the  strength  of  the  outstanding  bonds. 

These  bonds  are  so  well  distributed  among  the  different 
classes  of  clients  that  no  one  class  can  be  said  to  represent  a 
typical  distributing  market.  However,  several  of  the  offer- 
ings of  the  last  ten  years  with  common  stock  bonuses  which  have 
been  sold  at  a  discount,  must  be  considered  as  speculations  rather 
than  as  investments. 

The  majority  of  the  hydro-electric  bonds  that  have  come  on 
to  the  market  have  been  for  new  enterprises.  This  has  meant 
that  the  project  is  untried  and  the  risks  have  not  all  been 
tested.  The  dependence  of  the  project,  first,  on  the  reliability 
of  the  engineers'  estimates,  and  second,  on  the  available  market 
for  the  power  supply,  necessitates,  as  do  all  untried  enterprises 
a  very  close  examination.  When  the  interests  that  control  the 
water  supply  also  control  the  industry,  these  risks  are  mate- 
rially lessened  or  do  not  exist.  In  an  established  power-plant, 
the  possible  extensions  of  the  market,  alone,  need  careful 
scrutiny. 


CHAPTER  XXIII 
PEIYATE  WATEK  COMPANY  BONDS 

Water-works  companies  are  the  oldest  of  the  public  utili- 
ties. As  early  as  1592,  Peter  Morrys,  a  Dutch  engineer,  secured 
a  lease  on  one  of  the  arches  of  the  London  Bridge  and  con- 
structed a  system  for  distributing  water  through  wooden  pipes. 
This  was  known  as  the  Old  London  Bridge  Company. 

As  a  relatively  greater  proportion  of  the  water-works  plants 
in  the  large  cities  are  controlled  by  the  municipalities,  the 
total  capitalization  of  municipally  owned  plants  largely  exceeds 
the  capitalization  of  privately  owned  corporations.  Only  six 
cities  of  over  100,000  population  in  the  United  States  now  have 
privately  owned  plants.  And  it  is  an  acknowledged  fact  that 
the  movement  toward  municipal  ownership  is  increasing.  Even 
in  quarters  where  municipal  ownership  of  other  utilities  has 
been  bitterly  fought,  there  has  been  little  public  opposition  to 
the  municipalization  of  water-works  plants,  though  the  pro- 
prietors have  never  given  them  up  without  a  strong  fight.  As  a 
rule  conservatively  established  and  well  managed  water-works 
corporations  have  been  very  profitable.  They  are  simple  to 
operate  and  are  easy  to  maintain  when  well  constructed,  and  of 
all  the  public  utilities  are  the  easiest  to  manage  where  cordial 
public  relationships  have  been  established. 

Unfortunately,  many  private  water-companies  have  been  the 
easy  butt  of  unprincipled  political  bosses,  though  the  fraudu- 
lent practice  of  some  of  the  companies  in  the  early  years  of 
water-plant  development  gave  their  share  of  encouragement  to 
the  opposition  of  privately  owned  plants.  And  out  of  these 
early  experiences  developed  the  permanent  and  large  tendency 
toward  municipal  control.  Notwithstanding  this  tendency,  how- 
ever, probably  more  than  half  a  billion  in  securities  of  private 
water-plants  is  outstanding,  though  they  are  least  popular  as  a 
class  of  public  utility  securities. 

425 


426  INVESTMENT  ANALYSIS 

Territory  and  Population. — The  character  and  topography 
of  the  territory  in  which  a  water-system  is  located  determine 
whether  the  gravity  system  may  be  used  or  whether  continuous 
pumping  is  necessary.  The  latter  system  is  more  expensive  to 
build  and  to  maintain.  The  character  of  the  topography  and 
soil  also  makes  a  vast  difference  in  the  expense  of  installation 
and  maintenance  of  water-mains  and  aqueducts,  as  well  as  a 
difference  in  the  expense  of  obtaining  the  water  supply.  As 
with  all  public  utilities,  however,  these  physical  determinants 
must  be  studied  in  relation  to  both  the  number  and  distribution 
of  population.  A  widely  distributed  population,  especially 
where  pumping  is  required,  will  materially  increase  the  cost  of 
operation  as  well  as  of  construction.  A  number  of  instances 
are  to  be  found  where  a  city  much  smaller  in  population  but 
more  closely  concentrated  is  very  much  more  profitable  than  a 
larger  city  with  a  widely  distributed  population. 

A  considerable  variation  also  often  exists  in  water  consump- 
tion. A  wealthy  suburb  like  Evanston,  Illinois,  for  example, 
uses  a  very  much  larger  amount  of  water  than  the  majority  of 
cities  in  the  United  States  of  a  similar  size.  A  difference  will 
also  be  found  between'  cities  using  meters  and  cities  which  give 
unlimited  use  of  water.  As  metering  acts  as  a  check  on  the 
wasteful  use  of  water,  it  automatically  results  in  a  saving  to 
the  pumping  station.  Similar  variations  will  also  occur  in 
different  types  of  manufacturing  towns. 

Supply1  and  Quality  of  Water. — The  quantity  of  water  is 
the  first  requisite.  If  the  water  supply  does  not  measure  up 
to  the  proper  standard  of  purity,  it  can  be  filtered,  though  ex- 
tensive filtration  plants  add  materially  to  the  costs.  But  there 
is  no  substitute  if  the  quantity  of  water  needed  is  not  obtain- 
able. With  every  water-plant,  the  questions  to  be  raised  are: 
Has  the  present  water  supply  always  been  constant?  If  the 
rainfall  is  irregular,  are  the  reservoir  facilities  of  sufficient 
capacity  to  tide  the  demand  through  a  drought?  Is  the  water 
supply  sufficient  to  meet  the  increasing  demand  of  a  growing 

irThe  reader  should  review  the  topics  Water  Supply,  Storage  and 
Pondage,  Riparian  and  Public  Regulation  of  Water-power;  chap,  xxii — 
Hydro-Electric  Power  Securities. 


WATER  COMPANY  BONDS  427 

population,  and  for  how  long?  Are  there  any  sources  of  water 
supply  not  yet  tapped  that  will  be  available  and  what  will  be 
the  cost  of  securing  the  supply?  If  water  supplies  are  avail- 
able, what  difficulties  of  water  rights  may  arise?  Can  the 
gravity  system  used  be  employed,  especially  in  bringing  water 
from  greater  distances?  For  an  answer  to  these  questions  we 
are  dependent  on  the  engineer. 

A  water-works  company  will  usually  have  at  least  one  of 
five  sources  from  which  it  may  obtain  its  water  supply ;  namely, 
lakes,  rivers,  ponds,  springs,  and  wells.  The  engineering  prob- 
lems, involving  the  water  supply  and  the  difficulty  of  procuring 
it  from  one  or  more  of  these  sources  and  the  necessity  or  not  of 
filtration,  are  too  complex  to  allow  of  a  generalized  statement. 
The  engineering  problems  involving  the  cost  of  installation  and 
operation,  which  are  the  phases  of  the  problem  the  investor  is 
interested  in,  must  be  analyzed  in  each  individual  case. 

The  paramount  importance  of  the  quantity  and  quality  of 
water  supply  is  illustrated  by  the  efforts  of  New  York  City, 
through  an  expenditure  of  $162,000,000,  to  obtain  a  sufficient 
supply  which  would  be  outside  of  the  dangers  of  pollution. 
Los  Angeles  has  also  spent  an  enormous  sum  on  an  aque- 
duct which  brings  water  230  miles  from  the  mountains.  San 
Francisco  obtained  consent  of  the  Federal  government  to  con- 
struct a  dam  at  Hetch  Hetchy  in  order  to  obtain  its  supply  from 
the  Sierra  Nevada  mountains,  conveying  the  water  142  miles. 
New  Orleans  made  an  expenditure  of  $24,000,000.  A  number  of 
water  companies  in  the  older  and  larger  cities  have  suffered 
heavy  financial  losses,  as  the  cities'  growth  has  endangered  the 
purity  of  their  water  supply  and  forced  them  to  seek  new 
sources  of  supply.  The  vital  importance  of  the  purity  of  the 
water  supply  must  never  be  overlooked,  for  there  is  nothing 
that  will  so  completely  arouse  a  community  to  action,  and  with 
justice,  as  to  be  led  to  believe  that  the  safeguarding  of  the 
purity  of  the  water  has  been  neglected.  Companies  which  have 
followed  the  policy  of  overlooking  this  obligation  to  the  com- 
munity have  eventually  suffered,  and  in  some  cases  have  been 
forced  to  surrender  their  property  at  a  sacrifice. 

While  conveyance  of  water  from  a  great  distance  increases 


428  INVESTMENT  ANALYSIS 

cost  of  construction,  it  usually  guarantees  pure  water  without 
the  necessity  of  filtration.  Longer  transportation  also  gen- 
erally gives  an  even  greater  benefit  in  the  use  of  the  gravity 
systems.  In  a  greater  part  of  the  Ohio  and  Mississippi  Valleys 
the  gravity  systems  are  impossible  and  all  water  must  be 
pumped. 

Filtration  is  also  often  needed  in  this  area ;  and  since  filtra- 
tion adds  very  greatly  to  the  cost  of  operation  in  the  majority 
of  cases,  water  plants  so  affected  are  less  profitable.  With  cities 
and  towns  closely  adjacent  to  mountains  or  high  elevations  hav- 
ing a  water  supply,  even  the  initial  costs  of  gravity  systems  may 
be  nominal. 

Large  variables  exist  in  the  cost  of  constructing  and  main- 
taining supply  reservoirs.  The  topography  may  be  of  such 
character  that  the  building  of  a  reservoir  is  difficult  and  costly. 
In  other  instances  an  ideal  situation  may  exist  together  with  all 
material  for  construction  at  hand.  Again,  there  may  be  soil 
conditions,  and  difficulties  in  drainage  that  make  it  hard  to  pro- 
tect against  the  pollution  of  the  water. 

Statutory  legislation  and  court  decisions  affecting  water 
rights  vary  to  such  an  extent  among  the  various  states  that 
proper  legislation  protecting  the  present  and  future  water  sup- 
ply should  be  assured.1  Where  a  town  is  securing  its  water 
supply  from  a  river  it  is  quite  possible  under  some  existing 
statutes  for  the  water  to  be  diverted  for  another  purpose  far- 
ther up  the  stream.  Because  of  the  vital  necessity  of  water  to 
the  existence  of  human  beings,  however,  there  has  undoubtdly 
been  less  difficulty  in  securing  protective  legislation  and  fav- 
orable judicial  decisions  for  town  and  city  water  supply  than 
for  the  irrigation  and  water-power  projects.  Existing  legis- 
lation should  also  leave  no  doubt  as  to  the  possibility  of  pro- 
curing increased  water  rights  when  necessary  at  not  too  great 
a  cost.  The  profits  of  a  very  prosperous  water  plant  might  all 
be  requisitioned  for  several  years  as  the  result  of  difficulty  in 
obtaining  additional  water  rights. 


'See    topic    on    Riparian    Rights    in    chap,     xxii,    Hydro-Electric 
Securities. 


WATER  COMPANY  BONDS  429 

Plant  and  Equipment. — To  secure  an  accurate  estimate  of 
the  property  and  equipment,  it  is  again  absolutely  necessary 
to  have  an  engineer's  detailed  report.  Without  it  no  intelli- 
gent comparison  can  be  made  between  the  capitalization  and 
property  values.  A  well  constructed  building  and  water  mains 
of  good  cast  iron  throughout  the  system  with  a  capacity  to  take 
care  of  a  legitimate  expansion  constitute  as  near  a  permanent 
security,  outside  of  land  itself,  as  it  is  possible  to  find  in  the 
field  of  investments.  But  it  must  not  be  forgotten  that  fixity 
does  not  always  beget  profits.  If  pumping  is  required,  the  cost 
of  equipment  in  machinery  and  boilers  is  materially  increased, 
though  this  is  only  a  small  part  of  the  total  construction. 
Where  the  construction  has  been  well  done,  there  is  little 
depreciation,  for  deterioration  of  this  type  of  building  and 
water  mains  is  very  slow.  If  construction  has  not  been  such 
as  to  allow  for  the  needs  of  a  growing  city,  serious  losses  are  apt 
to  result  from  obsolescence  rather  than  from  the  actual  wearing 
out  of  buildings  and  equipment.  But  this  is  not  a  very  diffi- 
cult matter  to  ascertain.  The  danger  of  the  use  of  poor  mate- 
rial in  water-mains  which  can  be  covered  with  paint  and  then 
buried  is  less  prevalent  today  than  it  was  twenty-five  to  forty 
years  ago,  though  an  occasional  example  of  fraud  now  and  then 
comes  to  light. 

Depreciation. — Allowance  for  depreciation,  even  where  it  is 
as  slow  as  in  a  water  plant,  has  become  a  recognized  principle 
by  the  courts.  Though  the  exact  rate  and  method  of  procedure 
in  determining  what  it  shall  be  is  no  more  agreed  upon  with 
water  companies  than  with  other  public  utilities,  the  final  results 
are  for  all  practical  purposes  the  same.1  The  amount  of 
machinery,  etc.,  for  pumping  must  necessarily  account  for 
a  considerable  variation  in  machinery  investments.  With  a 
very  rapid  growth  in  population  obsolescence  may  become 
an  even  greater  item  and  require  a  corresponding  increase  in 
earnings. 


.;  Des  Moines  Water  Company  vs.  City  of  Des  Moines,  192 
Fed.  193.  Sept.  1C,  1911.  Knoxville  vs.  Knoxville  Water  Company,  212 
U.  S.  1,  14,  29.  Supreme  Court  148,  152,  C3  L.  Ed.  371. 


430  INVESTMENT  ANALYSIS 

Capitalization  and  Earnings.1 — The  majority  of  the  con- 
servatively managed  and  financed  private  water  companies  show 
a  capitalization  per  capita  of  population  served,  of  between 
thirty-five  and  forty-five  dollars.  Ordinarily  cities  and  towns 
below  50,000  population  should  not  have  a  capitalization  of  over 
forty  dollars  per  capita  if  the  securities  of  the  water-company 
serving  these  municipalities  are  to  be  classed  as  investments. 
Cities  above  50,000  can  safely  show  an  increasing  per  capita 
outlay,  though  the  large  majority  of  cities  above  50,000  have  a 
much  lower  capitalization  owing  to  the  large  population  per 
mile  of  main.  Over-capitalization  is  not  common,  though  a  few 
of  the  old  mismanaged  companies  still  carry  the  burden  of 
their  over-capitalization  of  earlier  days. 

With  the  exception  of  hydro-electric  power  companies,  water- 
companies  can  carry  a  much  larger  proportion  of  bonds  to 
stocks  than  any  other  type  of  public  utility.  The  proportion 
which  is  carried  by  some  conservatively  managed  and  capi- 
talized companies  would  spell  disaster  to  other  types  of  public 
utilities.  Examples  are  not  infrequent  of  a  funded  debt  of  from 
two  to  four  times  the  amount  of  capital  stock  outstanding. 


INCOME  ACCOUNT 
(Wisconsin  Railroad  Commission) 

I.  Operating  Revenues  Contingencies 
Earnings  from  Commercial  Sales  Taxes 

Earnings  from  Industrail  Sales  Total  Operating  Expense 

Earnings  from  Municipal  Hy-  Total  Net  Operating  Revenue 

drant  Rentals  Non-Operating  Revenue 

Earnings  from  Sales  for  Street  Total  Gross  Revenue 

Sprinkling  Total  Net  Revenue 

Earnings  from  Sales  to  Munici- 
pal Departments  III.  Deduction  from  Gross  Income 

Miscellaneous  Earnings  from  Interest  on  Funded  Debt 

Operation  Interest  on  Real  Estate  Mortgages 

Total  Operating  Revenue  Interest  on  Floating  Debt 

Sinking  Funds 

II.  Operating  Expense  Amortization  Reserves 
Pumping  Miscellaneous  Deductions 
Distribution  Total 

Commercial  Disposition  of  Net  Income 

General  Preferred  Stock  Dividend 

"Undistributed  Common  Stock  Dividend 

Total  Other  Payments 

Depreciation  Surplus  for  year 

(For  technical  unit  measurements,  see  this  topic  in  other  public 
utility  chapters.) 


WATER  COMPANY  BONDS  431 

and  a  few  companies  go  even  higher  than  this  ratio.  Though 
the  total  capitalization  rarely  exceeds  the  value  of  the  physical 
plant,  several  instances  exist  of  the  bonds  outstanding  equal- 
ing the  full  physical  value.  In  these  companies  the  capital 
stock  is  usually  quite  small,  and  thus  a  reasonable  dividend 
is  allowed  to  the  stockholders.  From  the  stockholders'  point 
of  view  this  has  a  decided  advantage  in  that  it  enables  them, 
with  a  small  amount  of  capital,  to  control  a  very  large  amount 
of  credit. 

Water-plants  have  the  advantage  of  neither  having  to  seek 
custom  nor  having  it  decrease.  There  is  no  practical  substitu- 
tion for  the  water  company  after  the  town  has  passed  the  stage 
of  individual  wells.  Neither  is  there  any  risk  of  payments  in- 
volved, for  the  water  companies  have,  happily  for  themselves, 
followed  the  precedent  of  the  municipalities  in  requiring  pay- 
ments quarterly  or  semi-annually,  and  if  payment  is  not  made, 
the  right  to  shut  water  off  is  exercised.  Consequently,  the  fluc- 
tuating risk  to  which  other  corporations  are  subjected  is  scarcely 
known  to  water  companies.  Where  the  future  expansions  have 
been  judiciously  provided  for  and  the  income  determined,  there 
is  a  minimum  risk  in  forcing  up  the  interest  charge  to  this 
fixed  income  after  a  reasonable  margin  of  safety  is  provided. 
As  a  matter  of  fact,  a  study  of  the  fixed  income  of  water  com- 
panies is  the  best  basis  for  determining  the  burden  of  the 
bonded  debt.  Where,  however,  a  large  ratio  of  funded  debt  leaves 
a  very  low  return  for  the  capital  stock,  the  interest  charge  does 
not  have  a  sufficient  margin  of  safety.  This  situation  signifies 
too  large  a  funded  debt  and  probably  over-capitalization. 

The  time  of  greatest  danger  for  water-works  companies  is 
during  the  period  of  their  development,  or  when  large  expan- 
sions of  old  companies  are  undertaken.  Construction  is  a  very 
slow  process,  and  delays  frequently  occur  that  materially  in- 
crease costs.1  The  temptation  during  this  construction  period  is 


'Nevada  and  Nebraska  commissions  in  earlier  rulings  refused  to 
make  any  allowances  for  the  development  period.  The  Wisconsin  Com- 
mission has  made  allowances  for  these  losses  for  the  development  period 
and  this  is  the  only  equitable  thing  to  do.  The  latter  Commission,  how- 
ever, does  retain  power  to  discount  any  extravagant  practices.  (Wis- 
consin K.  R.  Com.  vol.  iii,  p.  624  and  vol.  Iv,  p.  585.) 


432  INVESTMENT  ANALYSIS 

to  reduce  rates  in  order  to  secure  customers,  who  otherwise 
would  not  avail  themselves  of  the  use  of  the  system.  This  will 
eventually  mean  a  decided  reduction  in  net  profits,  for  the  whole 
community  must  sooner  or  later  be  given  the  same  rates,  as  the 
public  can  only  be  treated  as  a  group.  Furthermore,  as  water- 
works plants  are,  not  only  the  most  costly  to  install,  but  also 
slowest  of  the  public  utilities  to  develop,  the  long  period  dur- 
ing which  the  capital  must  be  tied  up  in  new  companies  before 
it  yields  any  very  lucrative  return  must  be  taken  into  account 
by  the  purchaser  of  the  security.1 

The  peak  load  factor  exists  in  water  systems,  though  when 
high  enough  stand-pipes  can  be  erected ;  and  especially  where  it 
is  possible  to  erect  them  on  high  elevations,  it  is  rarely  the 
serious  problem  it  is  with  electric  lighting  plants.  Nevertheless, 
even  with  stand-pipe  facilities,  the  fires  in  the  power  house  must 
be  kept  going  to  allow  of  a  quick  response  to  the  need  for  extra 
water  for  fires.  And  a  very  considerable  addition  to  the  oper- 
ating expense  is  incurred  in  keeping  the  plant  in  continual 
readiness  for  these  emergencies.  Normally,  fire  protection  costs 
increase  in  ratio  to  total  cost  as  the  city  decreases  in  size. 
"While  the  amount  of  water  actually  used  for  fire  protection 
is  less  than  3  per  cent  in  the  average  plant,  the  necessity  of 
being  prepared  for  an  extraordinary  demand  materially  in- 
creases, as  stated  above,  the  operating  expense.  As  the  peak  load 
requirements  in  equipment  and  pumping  for  ordinary  domestic 
service  are  but  a  small  part  of  the  fire  protection  requirements, 
the  conditions  affecting  the  demands  of  the  latter  require  the 
closer  analysis.' 

Franchise. — The  continued  tendency  toward  municipal  own- 
ership of  water  plants  should  warn  every  private  company  to 


aThe  operating  results  at  the  pumping-station  are  dependent  accord- 
ing to  J.  A.  Chester  on  the  following :  1.  quality  of  coal ;  2.  efficiency 
of  boilers ;  3.  efficiency  of  steam  lines ;  4.  station's  capacity ;  5.  head 
against  which  water  is  delivered ;  6.  load  factor ;  7.  adaptability  of  ma- 
chinery ;  8.  compactness  of  station ;  9.  low  vacuum  in  condensing  units, 
and  10.  care  in  operation  and  many  other  minor  elements. 

2Mr.  Allen  Dazen,  Meter  Rates  for  Water  Works  (1918),  pp.  164-168. 
Mr.  Halford  Erickson  (In  Proc.  American  Water  Works  Association. 
1913,  p.  56)  states  that  for  a  typical  water  works  plant  the  capacity 
expense  would  amount  to  38% ;  the  consumers'  expense  to  18%,  and  tt  • 
output  expense  to  44%  of  the  total  operating  expense. 


WATER  COMPANY  BONDS  433 

incorporate  the  provisions  affecting  confiscation  of  property  so 
as  to  enable  the  company  fully  to  discount  its  effects.  It  is 
hardly  safe  to  assume  that  a  company  even  with  a  long  termed 
franchise  is  immune  from  the  possibility  of  a  forced  surrender 
of  its  charter  rights.1  While  ultimately  an  advantage  will  prob- 
ably be  enjoyed,  a  temporary  relapse  of  security  prices  is  likely 
to  take  place. 

If  the  charter  is  not  endangered  by  confiscation,  the  rates,  if 
high,  will  sooner  or  later  be  adjusted  by  a  state  commission 
unless  there  is  some  very  positive  and  exceptional  reason  for 
the  maintenance  of  the  existing  rate.  Regardless  of  the  sweep- 
ing powers  that  an  old  franchise  may  possess,  it  is  well  to  dis- 
count the  possible  lowering  of  high  rates  where  they  exist,  and 
fix  the  value  of  the  utility  on  the  basis  of  what  the  rate  may 
be  made  for  future  investment  purposes.  In  the  Kenebec 
Water  District  case,  for  illustration,  the  Supreme  Court  of 
Maine  stated  clearly  the  attitude  of  the  courts  on  the  company's 
right  to  fix  rates  under  its  franchise : 

"The  Maine  water  company  is  a  quasi-public  or  public 
service,  corporation,  and  is  entitled  to  charge  reasonable  rates 
for  its  services,  and  no  more. 

"The  basis  of  all  calculation  as  to  reasonableness  of  rates  to 
be  charged  by  a  public  service  corporation  is  the  fair  value  of 
the  property  used  by  it  for  the  convenience  of  the  public. 

"At  the  same  time,  the  public  has  the  right  to  demand  that 
the  rates  shall  be  no  higher  than  the  services  are  worth  to  them, 
not  in  the  aggregate,  but  as  individuals. ' '  * 

On  the  other  hand,  there  is  far  less  danger  of  usurption 
where  an  equitable  rate  of  return  exists3  than  there  was  twenty 
years  ago;  nevertheless,  these  conditions  should  be  very  com- 
pletely stated  in  the  charter.  If  rates  are  reasonable,  there  is 
certainly  more  likelihood  of  a  franchise  renewal. 

Among  the  items  which  are  peculiar  to  a  water  plant  fran- 
chise and  should  be  covered  in  minute  detail  are:  (1)  The  mini- 


JAn  evidence  of  this  is  the  early  experience  of  the  Denver  Water 
Works  Company. 

2Kenebec  Water  District  vs.  City  of  Waterville,  97  Me.  185,  Att.  6, 
Supreme  Court,  Me.,  1902. 

"Spring  Valley  Water  Works  vs.  San  Francisco,  192  Fed.  137,  (1911). 


434  INVESTMENT  ANALYSIS 

mum  reservoir  water  supply  to  be  required;  (2)  the  methods 
by  which  the  water  will  be  tested;  (3)  the  details  and  prices  of 
the  contract  for  furnishing  the  city  water;  (4)  the  character  of 
specifications  for  all  constructions;  (5)  the  specification  as  to 
the  character  of  material  to  be  used;  (6)  the  conditions  under 
which  extensions  shall  be  made;  (7)  the  tests  required;  (8)  the 
terms  on  which  the  franchise  shall  be  surrendered  to  the  city 
which  safeguard  the  security  holders;  and  (9)  the  duration 
of  the  franchise. 

If  all  considerations  affecting  both  the  company  and  the 
public  are  fully  stated,  there  is  no  risk  as  to  changes  affecting 
the  company's  interests.  If  the  concessions  to  both  parties  are 
not  fully  stated  in  the  franchise,  they  must  ultimately  be  con- 
ceded, and  when  they  are  once  secured  on  this  basis,  risks  arc 
stabilized.  To  those,  of  course,  desirous  of  assuming  a  specula- 
tive risk,  such  carefully  drawn  concessions  would  not  appeal, 
but  the  investor's  endeavor  is  always  to  eliminate  the  risk  and 
strengthen  the  security. 

Bond  Market  and  Characteristics. — Well  selected  water 
company  bonds  are  undoubtedly,  as  a  class,  highly  desirable 
public  utility  securities.  The  market  except  for  the  larger  and 
some  of  the  better  known  issues  fe  rather  narrow.  Rarely,  how- 
ever, have  water  company  bonds  gone  begging,  for  they  have 
practically  always  been  quickly  absorbed  by  the  local  home 
market  of  the  company.  These  bonds,  though  possessing  an 
extremely  slow  convertibility  in  comparison  with  some  other 
bonds,  will  usually  be  taken  by  the  local  market.  Even  strained 
markets  have  experienced  considerable  eagerness  in  the  pur- 
chase of  sound  water  company  offerings.  Except  for  issues  of 
new  plants  or  for  extensions,  relatively  few  of  these  bonds 
appear  in  the  market. 

Practically  all  water  company  issues  now  provide  for  either 
the  sinking  fund  or  serial  payments.  While  either  the  sinking 
fund  or  serial  payment  clauses  are  found  in  the  indentures 
of  all  new  issues,  they  are  seldom  found  in  the  old  long  out- 
standing issues.  But  in  well-tested  water  companies  the  omis- 
sion of  either  one  of  these  requirements  is  not  subject  to  the 
same  criticism  as  it  would  be  in  other  classes  of  public  utilities. 
In  any  case  they  are  an  advantage  to  an  issue. 


CHAPTER  XXIV 
TELEPHONE  AND  TELEGRAPH  SECURITIES 

The  government  ownership  of  telephone  and  telegraph  lines 
in  Europe  has  been  influential  in  stimulating  considerable 
agitation  in  this  country  for  government  ownership  of  these 
public  utilities.1  Next  in  prominence  to  the  agitation  for  mu- 
nicipal ownership  of  water-works  has  been  the  advocacy  for 
Federal  ownership  of  telegraph  and  telephone  lines.  With  the 
smaller  units  and  the  simple  character  of  the  industry,  the 
management  of  water-works  has  been  a  relatively  easy  matter 
compared  to  the  control  of  companies  of  national  scope.  Advo- 
cates of  government  control  and  operation  of  these  larger 
companies  too  frequently  ignore  these  two  factors  so  funda- 
mental to  any  consideration  of  these  problems. 

If  government  control  is  ever  successfully  established,  the 
government  will  first  have  to  obtain  a  wider  understanding  of 
and  ability  to  manage  such  highly  developed  and  complex 
organizations  as  the  American  Telephone  and  Telegraph,  than 
it  now  possesses.  It  is  questionable,  then,  whether  govern- 
ment operation  can  be  carried  out  and  the  high  character 
of  past  service  be  continued.  The  remarkable  growth  and  the 
superiority  of  service  rendered  by  the  two  largest  relayers  of 
messages  in  this  country  compared  to  those  of  Europe  raise 
very  serious  objections  against  any  attempt  at  government 
control. 

In  Denmark,  where  most  of  the  telephones  are  privately 
owned,  there  are  two  and  one-half  times  as  many  telephones  as 
in  Great  Britain,  six  times  as  many  as  in  France,  and  twice  as 
many  as  in  Belgium  where  the  exchanges  are  controlled  and 

Tor  technical  forms  of  analysis  see  previous  topic  under  the  vari- 
ous chapters  of  public  utilities  and  the  form  of  the  A.  T.  $  T.  Co.,  given 
in  Appendix  D. 

435 


436  INVESTMENT  ANALYSIS 

operated  by  the  government.  Paris,  France,  which  is  more  than 
twice  as  large  as  Boston,  Massachusetts,  has  only  one-half  as 
many  telephones.  Liverpool,  England,  which  is  three  times  the 
size  of  Los  Angeles,  California,  has  only  one-third  as  many. 
All  Eussia  has  fewer  than  Philadelphia,  Pennsylvania,  and 
Toledo,  Ohio,  more  than  Spain.  And  this  is  the  experience  of 
every  other  country  whose  systems  are  exclusively  controlled 
by  the  government. 

Notwithstanding  that  the  original  telephone  patents  were 
operated  in  1878,  and  every  opportunity  has  existed  to  develop 
several  large  competing  companies,  a  large  part  of  the  business 
continues  to  be  dominated  by  the  Bell  Telephone  System.  Ap- 
proximately 80  per  cent  of  the  wire,  and  nearly  62.5  per  cent 
of  the  telephones  are  under  the  control  of  these  interests,1  and 
a  large  number  of  the  independents  use  their  lines  for  toll  ser- 
vice. If  the  latter  companies  are  included,  the  telephones  using 
the  Bell  System  equal  89.5  per  cent  of  all  telephones  in  the 
country.*  With  the  termination  of  the  original  patents  there 
was  a  very  rapid  growth  of  local  and  rural  mutual  systems.  The 
last  census  enumerated  the  total  number  of  telephone  com- 
panies at  52,234.  Many  of  these  have  only  a  few  miles  of  wire 
connecting  a  small  group  of  farmers.  Of  this  number  only  145 
companies  are  controlled  by  the  Bell  system;  but  the  Bell 
organization  controls  86  per  cent  of  the  income  from  all  tele- 
phone companies  of  the  country  so  that  the  greater  part  of  the 
independent  systems  have  no  interest  for  the  average  investor. 
In  fact  many  of  the  rural  telephones  are  installed  for  con- 
venience and  not  for  commercial  profit,  even  barbed  wire 
fences  being  utilized  as  transmission  wires  in  a  few  cases.  But 
even  with  the  almost  doubling  of  independent  rural  systems 
from  1901  to  1917,  the  fact  that  stands  out  most  significantly 
in  the  whole  enumeration  is  that  consolidations  still  continue 
among  the  larger  systems  where  commercial  demands  exist. 

The  particular  object  of  these  comparisons  has  not  been  to 
recommend  Bell  system  securities  but  to  shew  how  limited  are 


United  States  Bureau  of  Census,  Telephones  (1917)    (Printed  1920). 
This  includes  companies  having  an  income  over  $5,000  per  annum. 


TELEPHONE  AND  TELEGRAPH       437 

the  telephone  securities  which  can  be  classed  as  investments. 
And  the  advantages  of  the  larger  units  must  always  be  stressed 
as  peculiarly  valuable  in  telephone  securities.  If  only  a  local 
market  is  desired,  a  number  of  the  large  corporation  securities 
'of  the  independent  group  are  desirable  holdings;  but  if  a 
national  market  is  preferred,  the  purchaser  must  confine  him- 
self to  the  Bell  group. 

Telegraph  companies  are  even  fewer  in  number  than  tele- 
phone companies.  Until  very  recently  telegraph  companies 
have  had  an  absolute  monopoly  on  the  relaying  of  long  distance 
messages.  This,  together  with  the  economies  and  efficiency  in 
service  which  can  be  accomplished  by  sending  messages  over 
the  wires,  have  forced  the  consolidation  of  telegraph  companies. 
The  advantages  of  these  consolidations  are  discussed  in  the  fol- 
lowing topic. 

The  commercial  land  telegraph  companies  in  the  United 
States  in  the  last  census  numbered  twenty-one;  the  ocean  cable 
companies  having  stations  in  the  United  States,  seven.  All  but 
a  very  small  percentage  of  the  telegraph  wires  and  ocean  cables 
are  in  the  control  of  the  American  Telephone  and  Telegraph, 
and  the  Mackay  Companies,  and  a  study  of  telegraph  securities 
for  investment  is  confined  to  these  two  companies.  The  wire- 
less companies  are  still  in  such  an  uncertain  financial  state, 
that  they  must  be  classed  as  purely  speculative  and  are  not 
considered  in  this  discussion. 

The  land  telegraph  systems  in  the  United  States  are  of  much 
less  importance  financially  than  telephone  companies,  having  a 
total  in  assets  of  about  one-sixth  of  those  of  telephone  com- 
panies and  about  one-seventeenth  of  the  net  income. 

Advantages  of  Large  Organization. — Efficient  telephone  ser- 
vice should  insure  communication  between  all  telephone  users 
in  the  same  community.  The  only  way  in  which  this  can  be 
done  is  by  the  entire  elimination  of  competition.  In  order  to 
render  this  kind  of  service,  all  service  telephone  lines  must  be 
under  the  control  of  one  organization.  Any  other  form  of  or- 
ganization than  a  monopoly,  then,  is  a  disadvantage  to  the  com- 
munity if  equitable  rates  are  provided  by  the  telephone  com- 
pany  to  its  subscribers.  The  next  question,  then,  normally 


438  INVESTMENT  ANALYSIS 

raised  is  whether  the  control  shall  be  under  a  regulated  private 
company  or  municipal  ownership.  The  weight  of  evidence,  if 
the  character  of  the  service  means  anything,  is  overwhelmingly 
in  favor  of  the  former. 

In  no  other  public  utility  have  the  important  companies  been 
so  effectively  centralized  as  in  the  telephone  corporations. 
While  very  large  credit  must  be  given  to  the  master  brains  who 
have  guided  these  great  consolidations,  the  character  of  the 
industry  has  been  such  as  to  force  it  ultimately  to  yield  to  the 
large  unit  organization.  This  has  been  evidenced  by  the  experi- 
ence of  every  commercial  and  industrial  community  of  impor- 
tance in  the  country,  and  even  in  the  smaller  communities, 
where  the  inconvenience  of  competing  systems  is  still  borne, 
the  constant  pressure  is  for  consolidation.  Where  duplication 
does  exist,  the  poor  service,  which  generally  attends  it,  is 
sometimes  somewhat  mitigated  by  intercommunication  service 
lines  and  the  regulations  governing  trunk-line  service.  But 
this  condition  is  likely  to  result  in  a  lessening  of  the  efficiency 
of  the  local  service  or  in  a  duplication  of  costs  to  the  community. 

The  cheapness  and  the  simplicity  of  managing  small  units 
have,  however,  brought  into  existence  hundreds  of  companies 
in  small  towns  and  rural  communities.  A  considerable  num- 
ber of  rural  lines  which  have  had  no  other  demand  upon 
them  than  the  demands  of  purely  rural  communication,  have 
successfully  continued  existence  as  more  or  less  communistic 
organizations.  But  where  these  systems  have  increased  in  size, 
the  demands  for  better  service  and  organizations  have  forced 
centralization  and  consolidation. 

Because  of  the  great  advantage  of  centralization,  it  is 
argued  by  many  that  control  of  all  telephones  and  telegraphs 
should  be  taken  over  by  the  Federal  government,  and  Federal 
buildings  and  the  postal  organization  be  utilized.  A  discussion 
of  this  subject  does  not  come  within  the  province  of  this  book, 
but  bondholders  need  have  little  concern  for  their  holdings 
should  the  properties  ever  be  confiscated  by  the  government. 
While  even  greater  concentration  is  to  be  desired  than  exists 
now,  the  experience  of  municipally  controlled  telephone  prop- 
erties in  Europe,  when  contrasted  with  the  telephone  service  in 


TELEPHONE  AND  TELEGRAPH       439 

this  country,  does  not  convince  one  of  the  desirability  of  gov- 
ernment ownership. 

For  the  investor,  therefore,  large  telephone  organizations 
offer  the  greatest  security.  Exceptions  and  qualifications  enter 
into  the  selection  of  any  standard  security,  however,  and  a 
great  number  of  small  telephone  corporations  have  been  highly 
successful. 

The  dependence  of  the  telegraph  on  business  and  its  more 
limited  use,  makes  a  larger  unit  even  more  imperative  than 
with  the  telephone.  In  fact  only  a  very  large  system 
could  ever  be  considered  as  possessing  all  the  safeguards 
required  by  an  investor.  As  the  greater  part  of  the  revenue  is 
wholly  dependent  on  financial,  manufacturing,  and  commercial 
organizations  and  these  businesses  must  have  communication 
over  a  large  geographical  area,  there  can  be  no  room  for 
argument. 

To  render  the  long  distance  service  of  the  telegraph  com- 
panies effective,  a  large  initial  outlay  is  required.  And  as  the 
rate  which  can  be  charged  for  this  service  cannot  be  put  below 
the  cost  of  that  service  plus  a  reasonable  return  on  the  invest- 
ment, a  number  of  duplicate  organizations  could  not  be  sup- 
ported. As  a  consequence,  the  development  in  telegraph  com- 
panies has  been  a  logical  one  and  at  the  same  time  the  most 
economical  to  the  public.  If  graft  has  been  exercised  in  the 
development  of  any  of  the  telegraph  companies,  before  their 
final  absorption — that  is  quite  another  matter  and  is  not  an 
argument  against  the  logical  form  that  these  organizations  must 
take. 

As  a  result,  there  has  been  a  clear  demarcation  between  long- 
distance and  local  communication.  With  the  former,  costs  must 
obviously  be  higher.  The  further  result  of  these  controlling 
economic  factors  has  been  to  confine  the  use  of  the  telegraph 
largely  to  commercial  enterprises  which  are  warranted  in  carry- 
ing these  higher  charges. 

Cost  of  Construction  and  Operation. — Tt  is  a  fact  commonly 
accepted  by  engineers,  that  the  cost  of  telephone  service  in  cities 
above  a  certain  size  increases  at  an  increasing  rate  as  tele- 


440  INVESTMENT  ANALYSIS 

phones  are  added  to  the  system.  But  the  income  and  costs 
of  operations  cannot  be  analyzed  with  the  same  exactness 
as  can  other  public  utilities  on  the  basis  of  decreasing  costs  and 
increasing  population.1 

Mr.  Gansey  R.  Johnson,  commenting  upon  costs  of  telephone 
operation  in  the  annual  report  of  the  American  Telephone  and 
Telegraph  Company,  says  in  part :  ' '  The  construction  of  the  new 
lines  average  greater  because  the  average  length  of  line  increases 
with  the  growth  of  the  plant.  The  construction  cost  of  the 
switchboard  connections  for  both  the  old  and  the  new  lines  in- 
crease because  facilities  must  be  provided  at  the  switchboard  to 
connect  each  line,  old  and  new,  with  every  other  line,  as  well  as 
extra  facilities  for  the  additional  traffic.  The  unit  of  operation 
cost  increases  because  as  new  connections  are  provided  there  is 
additional  use  of  each  line.  ...  If  the  plant  is  trebled,  then 
the  limit  of  the  demand  is  measured  by  a  number  of  nine  times 
the  first  one  .  .  .  while  the  actual  demand  never  approaches 
the  greater  ratio  than  by  simple  addition. ' ' a 

The  greater  efficiency  in  both  administration  and  operation, 
in  the  large  system,  however,  offsets  to  a  considerable  degree, 
the  increased  costs  in  central  station  equipment  and  operation. 
Risks  are  also  reduced,  because  of  greater  geographical  distri- 
bution, and,  as  suggested  elsewhere,  equipment  can  be  purchased 
to  greater  advantage.  In  large  industrial  and  commercial  cen- 
ters the  equipment  that  must  be  displaced  in  order  to  provide 
for  improved  and  larger  facilities  can  be  used  in  the  new  adjust- 
ments needed  in  smaller  exchanges  of  the  system.  And  a  large 
system  can  also  control  the  manufacture  of  telephone  equip- 
ment, as  the  Bell  system,  a  subsidiary  to  the  American  Tele- 
phone and  Telegraph  Company  does  in  its  control  of  the  West- 
ern Electric  Company.  But  the  larger  and  better  service  ren- 
dered to  the  subscribers  must  not  be  lost  sight  of  in  a  study 
of  costs. 


^Report  of  the  Committee  on  Gas,  Oil  and  Electric  Light,  of  the 
City  Council  of  Chicago,  Sept.  3,  1907,  on  Telephone  Service  and  Rates, 
p.  74. 

*8ome  Comments  on  the  1907  Annual  Report  of  the  American  Tele- 
phone and  Telegraph  Company,  p.  5. 


441 

The  most  comprehensive  view  of  plant  values,  construction 
costs,  and  operation  expenses  of  any  system  can  best  be  obtained 
by  taking  into  account  the  relation  of  these  factors  to  the 
changes  in  outside  equipment,  central  office  equipment,  the  kind 
of  service  given,  the  increase  of  business,  and  the  change  in 
rates.  The  equipment  in  a  new  company  has  always  been  of 
the  simplest  type,  if  the  company  has  grown,  it  has  been  rap- 
idly displaced  as  needs  arose,  and  new  inventions  have  been 
made.  Light  poles  widely  separated  are  replaced  by  heavy 
poles  closely  placed,  grounded  circuits  are  replaced  by  metallic 
cables,  and  simple  operating  boards  are  replaced  by  several 
switchboards  that  form  a  complete  system.  The  stage  that  has 
been  reached  in  development  must  consequently  have  a  very 
important  bearing  on  any  conclusions  drawn  on  construction 
costs  or  valuation  of  property. 

The  Bell  system  concerning  which  the  most  complete  data 
can  be  obtained  for  the  purpose  of  drawing  conclusions  on 
financial  operations,  has  had  a  range  of  operation  expense  to 
telephone  earnings  of  from  32.6  per  cent  in  1895  with  a  steady 
increase  to  38.9  per  cent  in  1917.1  Telephone  expenses  to  tele- 
phone earnings  for  the  same  period  have  advanced  from  67.3 
per  cent  to  78.4  per  cent.  Depreciation  and  maintenance  have 
approximated  about  9  per  cent.2  The  average  operating  expense 
to  gross  earnings  of  independents  having  an  income  above 
$5,000  for  the  same  period,  was  70  per  cent.  The  United 
States  Census  indirectly  gives  us  another  line  of  evidence  in 
the  difference  in  dividends  earned  by  the  Bell  and  independ- 
ent systems,  a  difference  which  would  be  even  greater  if  the 
independents  had  provided  an  adequate  maintenance  charge. 
The  Bell  system  paid  an  average  of  7.30  per  cent  (in  1917) 
on  its  common  stock  outstanding,  and  the  independent  com- 
panies having  over  $5,000  income,8  an  average  of  3.17  per 
cent  on  common  stock  outstanding.  This,  of  course,  does  not 


JData  taken  for  year  prior  to  complete  government  control  because 
they  more  nearly  reflect  normal  results  under  private  control. 

^Annual  Report  of  the  American  Telephone  and  Telegraph  Company 
for  1917.  p.  13. 

*United  States  Bureau  of  Census  on  Telephones,  1917  (printed  1920), 
p.  42. 


442  INVESTMENT  ANALYSIS 

give  the  status  of  all  independents  any  more  than  a  general 
average  of  a  group  of  industrials  would  give  the  status  of  the 
International  Harvester  Company.  It  does,  however,  indicate 
that  there  are  a  very  large  number  of  companies  paying  no 
dividends  or  very  small  dividends.  It  also  shows  the  very 
successful  operation  of  the  whole  Bell  group  or  at  least  a  very 
large  part  of  it. 

A  great  deal  of  the  old  wire  mileage  of  the  telegraph  com- 
panies was  built  of  iron,  and  as  this  must  be  replaced  by 
copper,  it  will  place  a  rather  heavy  burden  on  some  of  the 
subsidiaries,  for  some  of  them  have  made  no  provision  for 
depreciation : 

"The  price  of  service  must  cover  the  costs  entailed  by  the 
investments.  .  .  .  The  cost  of  this  equipment  is  independent 
of  the  amount  per  hour  that  the  lines  may  be  utilized  to  convey, 
and  this  investment  is  the  same  whether  the  number  of  mes- 
sages put  over  the  line  is  large  or  small.  But  the  larger  use 
which  is  made  of  busy  lines,  such  as  a  largely  used  flat-rate  line 
uses  up  more  than  an  even  proportion  of  switchboard  space  and 
consequent  switchboard  investment.  .  .  .  There  is  thus  an 
investment,  which  it  may  be  readily  observed  is  fixed,  whether 
the  number  of  messages  over  the  line  is  large  or  small.  We  may 
call  this  the  readiness  to  serve  investment,  because  it  must  be 
provided  before  service  can  be  renderd  to  all.  It  includes  sub- 
scribers' lines  and  instruments  and  a  small  portion  of  the 
switchboards  with  appropriate  parts  of  real  estate  and  other 
tributary  property.  Likewise,  there  is  also  a  portion  of  invest- 
ment which  depends  upon  the  number  of  messages  sent  over  the 
line.  We  may  call  this  'service  rendered'  investment,  because 
it  is  dependent  upon  the  amount  of  the  traffic;  that  is,  the 
amount  of  service  rendered.  This  is  more  particularly  invest- 
ment in  switchboard,  etc.  .  .  .  Indeed,  certain  subscribers  en- 
tail an  expense  upon  the  company  several  times  that  entailed 
by  other  subscribers,  even  though  each  uses  service  over  a  line 
of  the  same  character.  .  .  .  These  differences,  as  already 
pointed  out,  affect  the  investment  requisite  to  serve  the  differ, 
ent  classes,  but  they  still  more  affect  the  daily  operating  costs. 
For  instance,  the  party  who  has  a  single  party  line  measured- 
rate  telephone,  and  uses  it  only  four  or  five  times  a  day,  may 
be  grouped  at  the  central  office  switchboard  with  perhaps  a 
hundred  other  users  and  their  requirements  served  by  a  single 
operator  .  .  .  while  the  flat  rate  user  makes  a  demand  on 
operators'  service  which  is  so  great  that  one  operator  can  only 


TELEPHONE  AND  TELEGRAPH       443 

take  care  of  a  few  subscribers.  .  .  .  Again  it  is  manifest  that 
subscribers  who  originate  any  number  of  messages  over  their 
line  during  a  particular  hour  of  the  day,  and  use  it  sparingly 
during  the  other  hours,  may  be  less  economically  served  than 
subscribers  whose  service  is  more  uniformly  distributed 
throughout  the  business  day."1 

Depreciation  and  Maintenance.  —  One  of  the  constantly  re- 
curring conditions  found  by  both  the  large  independent  and 
Bell  telephone  systems  in  taking  over  small  properties,  is  the 
lack  of  a  depreciation  fund.  Many  of  these  companies,  which 
have  been  absorbed,  have  had  to  be  entirely  rehabilitated.  Ob- 
solescence in  equipment  alone  has  been  a  very  large  charge, 
and,  as  with  all  electrical  devices,  the  inventions  of  new  tele- 
phone equipment  have  multiplied  very  rapidly.  The  failure  to 
make  provision  for  depreciation,  has,  as  a  result,  been  a  fre- 
quent cause  for  the  failure  of  telephone  companies. 

Large  irregular  maintenance  charges  from  the  destruction 
of  wires  by  storm  are,  however,  the  greatest  strain  on  small  com- 
panies. Large  companies,  especially  if  their  wires  are  distrib- 
uted over  a  wide  geographical  area,  reduce  this  risk  ;  i.  e.,  this 
distribution  constitutes  a  partial  insurance.  But  the  entire 
wire  mileage  of  a  small  company,  which  operates  within  a  nar- 
row geographical  area,  may  be  completely  crippled  by  a  single 
storm.  In  such  a  case,  the  company's  service  is  tied  up  for  a 
long  period,  as  there  is  no  extra  laboring  force  to  concentrate  on, 
this  emergency  repair  work.  And  with  the  very  common  practice 
among  the  smaller  independent  telephone  companies  of  maintain- 
ing small  reserves,  the  situation  is  increasingly  embarrassing. 
The  seriousness  of  such  extraordinary  losses  is  well  illustrated  by 
the  experience  of  the  Chesapeake  and  Potomac  Telephone  Com- 
pany in  Baltimore,  at  the  time  of  its  destructive  fire. 

The  more  prevalent  rate  of  depreciation  allowed  by  com- 
missions and  courts  is  about  7  per  cent,  assuming  that  the  equip- 
ment has  a  life  of  twelve  years.3  The  Missouri  Supreme  Court 
in  the  Home  Telephone  case  allowed  a  depreciation  fund  of  $4 


'Pioneer  Telegraph  and  Telephone  Company  vs.  Westhaver,  118 
Pac.  354,  January  10.  1911  ;  Cumberland  Telephone  and  Telegraph  Com- 
pany vs.  City  of  Louisville,  187  Fed.  637,  655,  Apr.  25,  1911. 


444  INVESTMENT  ANALYSIS 

per  telephone  per  annum,  which  is  approximately  5  per  cent  of 
the  property  value.1  The  method  adopted  by  the  Chicago  Tele- 
phone Commission  involves  a  constant  8  per  cent  charge  against 
the  plant  (on  a  net  cash  basis),  the  sinking  fund  for  this  pur- 
pose being  deposited  at  3  per  cent.2  The  Wisconsin  commis- 
sion in  commenting  on  the  Chicago  method  states:  "Conditions 
prevailing  at  the  Marinette  exchange  of  the  Wisconsin  Tele- 
phone Company,  call  for  a  depreciation  allowance  of  10  per  cent. 
The  reason  for  the  lower  rate  in  Chicago  is,  that  the  greater 
part  of  the  cable  plant  in  Chicago  is  underground  where  it  is 
permanent  and  relatively  out  of  danger,  the  greater  portion  of 
the  cable  in  Marinette  is  open,  overhead,  subject  to  sleet  storms, 
high  winds,  gales  and  the  like."8  A  few  cases  have  justified 
a  12  per  cent  rate,  but  the  range  from  6  to  10  per  cent  covers 
the  usual  charges  that  should  be  allowed.  Allowances  must  be 
made  both  for  the  rate  allowed  on  the  sinking  fund  and  the 
variable  conditions  that  may  exist,  as  suggested  by  the  Wiscon- 
sin commission. 

Public  information  concerning  the  depreciation  of  telegraph 
companies  has  never  been  very  complete.  The  life  of  outside 
equipment  is  approximately  the  same  as  that  of  the  telephone, 
but  the  inside  equipment  is  neither  as  expensive  nor  has  it  been 
subject  to  as  many  radical  changes  and  vicissitudes  as  the  tele- 
phone. Neither  have  the  mechanical  complexities  of  the  equip- 
ment necessitated  costly  expenditures  and  maintenance  charges. 

Rates.— No  sufficiently  large  compilation  of  rates  has  been 
made  to  give  any  very  authentic  basis  for  general  conclusions.4 
The  changes  and  the  rapidity  with  which  telephones  have  had 
to  be  installed,  variations  in  the  units  used,  the  number  of  tele- 


'Home  Telephone  Company  vs.  City  of  Carthage,  235  Mo.  644,  139 
S.  W.  547,  March  21,  1911. 

2See  also  William  H.  Hagenah's  Report  on  the  Investigation  of  the 
Chicago  Telephone  Company  to  the  Committee  on  Gas,  Oil  and  Elec- 
tricity, May  2,  1911,  pp.  16-35. 

8E.  E.  Payne  et  al.  vs.  Wisconsin  Telephone  Company,  decided  Au- 
gust 3,  1909,  by  the  Railroad  Commission  of  Wisconsin  (this  case  con- 
tains an  extensive  discussion  of  the  depreciation  problem  of  telephone 
companies). 

'The  most  comprehensive  tabulation  of  exchange  rates  yet  made  is 
that  of  the  Bureau  of  the  United  States  Census,  1912,  of  252  exchanges, 
which,  of  course,  is  out  of  date. 


TELEPHONE  AND  TELEGRAPH       445 

phones  installed,  the  number  of  central  offices  required,  the 
ordinances  regulating  the  placing  of  wire,  and  the  price  of 
labor,  are  all  reflected  in  the  gross  earnings.1 

The  cost  of  installation,  for  example,  will  show  a  very  wide 
fluctuation.  In  cities  where  the  population  is  very  mobile, 
changes  will  be  very  frequent.  The  same  census  report  referred 
to  above  states  : 

"It  is  well  known  that  the  proportion  of  illiterates,  the  pro- 
portion of  foreign  born,  the  average  income  of  the  inhabitants, 
commercial  and  social  activity,  and  topographical  conditions 
differ  very  widely  in  various  communities  of  the  sane  size,  and 
that  these  differences  are  naturally  reflected  in  the  character 
and  volume  of  telephone  service  in  such  a  manner  as  to  affect 
rates. 

' '  There  are  also  some  factors  of  commercial  and  social  char- 
acter of  such  peculiar  importance  in  connection  with  telephone 
rates  that  in  exchanges  of  the  same  size  and  of  the  same  gen- 
eral character  a  particular  schedule  of  rates  will  be  remunera- 
tive where  these  factors  are  present  and  result  in  a  deficit  where 
they  are  absent." 

State  Commissions  have  not  always  given  legitimate  atten- 
tion to  the  importance  of  these  differences.  Some  decisions 
show  evidences  that  there  has  been  an  attempt  to  recognize 
them,  but  they  are  not  always  as  carefully  analyzed  as  they 
should  be,  because  of  a  lack  of  a  true  appreciation  of  the  prob- 
lem. The  greater  danger  has  more  often  existed  in  the  com- 
pany's own  construction  policy,  and  under  competition  it  has 
been  forced  to  lower  rates  and  pay  dividends  to  the  neglect  of 
depreciation  and  maintenance.  The  courts  have  left  the  matter 
of  rate  charges  fairly  elastic  by  fixing  the  rate  of  return  of  the 
company  and  not  the  rate  charge  to  the  consumer.  Thus  if  a 
reasonable  rate  has  been  determined  by  the  court,  charges  must 
move  up  and  down  upon  the  basis  of  cost."  But  no  commis- 


^TelepJwnes,   Telegraphs   and  Municipal  Signaling  System,    United 
States  Census  Bureau,  chap,  iv  (1912). 


"Louisiana  R.  R.  Commission  vs.  Cumberland  Telephone  and  Tele- 
graph Co.  212  U.  S.  414,  29  Sup.  Ct.  53,  ed.  577,  Feb.  23,  1909.  City  of 
Owensboro  vs.  Cumberland  Telephone  and  Telegraph  Co.  174  Fed.  739, 
99  C.  C.  A.  December  14,  1909.  Home  Telephone  Co.  vs.  City  of  Car- 
thage 235,  No.  644,  139,  S.  S.  May  21,  19.M. 


446  INVESTMENT  ANALYSIS 

sion  or  court  ruling  should  be  allowed  to  deny  the  proper 
reward  for  the  exceptionally  skilful  management  that  secures 
economy.1 

Telegraph  companies  have  undoubtedly  checked  the  growth 
of  their  business  to  some  extent  by  not  lowering  rates,  until  very 
recent  years.  The  limited  capacity  of  a  Morse  operator  to 
handle  more  than  a  given  amount  of  work  will  not,  however, 
permit  of  reduction  below  a  certain  rate.  If  this  cost,  together 
with  the  large  installation  cost  of  a  plant  covering  sufficient 
territory,  had  made  competition  profitable,  it  would  have 
brought  a  very  much  larger  group  of  companies  into  existence. 
Loss  from  this  policy  will  never  again  arise ;  public  utility  cor- 
porations fully  appreciate  that  even  if  a  monopoly  is  held,  that 
a  forced  price  may  defeat  their  own  purpose. 

Bond  Characteristics  and  Market. — As  previously  stated, 
the  only  securities  of  the  telephone  and  telegraph  companies  in 
the  United  States  that  have  a  very  wide  market  are  those  of 
the  American  Telephone  and  Telegraph  and  the  Mackay  Com- 
panies, and  their  subsidiaries.  A  number  of  the  larger  inde- 
pendents have  a  fairly  active  local  market  though  not  in  any 
sense  a  national  one.  And  even  with  these  large  systems, 
it  is  only  the  parent  companies  and  the  larger  subsidiaries  that 
have  a  national  market. 

The  ratio  of  bonds  to  the  total  capitalization  in  both  tele- 
phone and  telegraph  companies  as  compared  to  other  public 
utilities  is  normally  low  in  the  stronger  companies.  This  is  as 
it  should  be,  because  of  the  relatively  larger  special  risks.  Un- 
der average  conditions,  interest  charges  are  earned  several  times 
over,  but  if  a  very  disastrous  storm  should  occur,  all  earnings 
and  surplus  might  be  wiped  out  in  this  one  extraordinary  ex- 
pense. It  is  in  the  organization  which  is  large  enough  to  cope 
safely  with  these  risks  that  the  investor  should  make  his  pur- 
chases. 


Arizona  Corporation  Commission  vs.  Morenci  Water  Co.,  June  9. 
1915. 


CHAPTER  XXV 
GREAT  LAKES  STEAMSHIP  BONDS 

Steamship  bonds  are  probably  the  least  known  of  any  class  of 
investment  securities.  Considerable  skepticism  exists  as  to  the 
safety  of  these  bonds  among  certain  investing  institutions  and 
the  state  banking  departments  of  the  states  more  remote  from 
the  Great  Lakes  states.  This  is  due  to  the  general  fear  of  mari- 
time risks  and  ignorance  of  the  safeguards  that  have  been 
placed  about  the  Great  Lakes  steamship  securities.  Also  the 
last  named  securities,  the  most  desirable  of  the  steamship  bonds, 
are  of  comparatively  recent  origin.  Bonds  on  the  Great  Lakes 
steamships  have  come  into  existence  since  the  construction  of 
steel  vessels,  as  no  bonds  are  issued  on  wooden  vessels,  excepting 
where  a  bond  issued  on  a  fleet  may  include  a  few  vessels  of  the 
old  wooden  type.  Usually,  in  such  cases,  very  little  value  is 
given  to  these  vessels.  Although  the  first  steel  vessel  on  the 
Great  Lakes  was  launched  about  1885,  it  was  not  till  after  1890 
that  steel  came  into  common  use  in  the  construction  of  lake 
steamers,  though  it  was  already  extensively  used  before  this 
date  on  ocean  going  vessels.  As  a  result,  while  there  has  been 
a  very  rapid  increase  in  the  number  of  steel  vessels  on  the 
Great  Lakes,  there  is  still  a  much  larger  tonnage  of  wooden 
vessels.1 

The  inter-related  control  of  the  steamship  lines  by  the 
railroads  doing  coastwise  shipping  prior  to  the  Great  War  and 
the  small  amount  of  American  capital  in  the  foreign  carrying 
trade,  due  to  our  navigation  laws,  have  discouraged  investment 
in  these  latter  companies.  The  issues  of  a  corporation  like  the 
United  States  Fruit  Company  or  the  Standard  Oil  Companies 
which  own  a  considerable  number  of  fleets,  cannot  be  consid- 

*Report  of  Bureau  of  Ndvigation  of  the  United  States,  1919. 

447 


448  INVESTMENT  ANALYSIS 

ered  in  a  general  discussion  of  steamship  securities,  as  such  a 
large  part  of  their  holdings  are  in  other  properties.  And  the 
unhappy  experience  of  the  largest  of  the  foreign  carrying  com- 
panies, the  International  Mercantile  Marine  has  not  given  the 
ocean  steamship  securities  an  enviable  reputation  despite  the 
fact  that  the  holders  of  these  bonds  were  fully  compensated. 
What  the  influence  of  the  War  and  the  development  of  the  con- 
struction of  ocean  going  vessels  will  be,  it  is  too  early  to  pre- 
dict. A  proper  correction  of  our  navigation  laws,  which  would 
make  it  possible  to  compete  with  the  carrying  trade  of  other 
countries,  would  build  up  a  shipping  trade  equal  to  that  of  the 
old  skipper  days. 

The  Great  Lakes  steamship  securities,  on  the  other  hand, 
have  had  an  enviable  reputation.  It  is  safe  to  assume,  on  the 
basis  of  correspondence  with  the  principal  banks,  trust  com- 
panies, and  bond  houses  of  the  chief  lake  port  cities,  that  no 
Great  Lakes  steamship  bond  issue,  up  to  date,  has  ever  defaulted. 
A  conservative  investment  house  of  Chicago,  which  has  dealt 
more  largely  in  these  securities  than  any  other  house  in  that  city, 
states  in  one  of  its  published  circulars  that:  "Steamship 
bonds  have  a  splendid  record.  We  are  not  aware  of  a  single 
instance  of  loss  to  investors  in  this  class  of  securities."1 

The  ruling  of  the  Interstate  Commerce  Commission  requir- 
ing a  separation  of  the  control  of  steamship  companies  and 
railroads  may  have  a  temporary  effect  on  the  development  of 
lake  shipping,  but  it  cannot  long  affect  Great  Lakes  steamship 
bonds.  The  effect  of  this  ruling  upon  steamship  securities  has 
not  been  as  great  as  many  had  anticipated,  as  the  steamers  con- 
trolled by  the  railroads  were  financed  through  the  railroad 
companies.  The  laws  affecting  ocean  going  trade  are  a  serious 
menace.  However,  this  subject  is  not  within  the  province  of 
this  chapter. 

Classes  of  Bonds. — There  are  four  general  classes  of  steam- 
ship bonds:  first,  those  secured  by  a  lien  on  a  single  vessel; 
second,  those  secured  by  a  lien  on  a  fleet;  third,  those  secured 
by  a  lien  on  a  fleet  or  single  vessel  and  other  properties;  and 

^Circular  of  Pcabody  Houghtcling  <£  Co. 


GREAT  LAKES  STEAMSHIP  449 

fourth,  those  issued  by  holding  companies  on  the  collateral 
security  of  stocks  and  bonds  of  subsidiary  companies. 

The  importance  of  the  third  type,  commonly  known  as  the 
debenture  or  blanket  mortgage,  varies  with  the  value  of  ter- 
minals and  other  holdings.  Bonds  of  the  third  class,  as  well  as 
those  of  the  first  and  second,  should  always  be  a  first  lien  on 
the  properties  mortgaged.  The  fourth  type  is  used  only  by 
holding  companies  of  coastwise  and  foreign  going  vessels. 
Where  there  is  a  large  group  of  subsidiary  securities,  the  distri- 
bution of  risks,  other  things  being  equal,  would  make  these 
securities  very  desirable.  It  would,  therefore,  be  necessary  to 
examine  each  subsidiary  company  to  ascertain  the  value  of  the 
collateral  security.  But  these  latter  have  never  had  the  envi- 
able reputation  possessed  by  the  securities  of  either  the  Great 
Lakes  single  vessel  securities  or  the  blanket  mortgages  bonds 
on  a  fleet  of  vessels. 

Physical  Properties. — "Where  a  large  amount  is  placed  upon 
one  vessel  or  a  small  group  of  vessels,  the  necessity  of  a  high 
standard  of  maintenance  is  obvious.  The  deterioration  or  lack 
of  repair  of  certain  parts  of  a  vessel  would  put  it  out  of  com- 
mission, and  as  the  vessel  cannot  be  put  to  any  other  service, 
it  becomes  in  such  case  valueless.  No  danger  of  loss  exists  from 
the  ordinary  service  of  lake  steel  vessels,  if  kept  in  proper 
repair,  as  their  life  is  conservatively  estimated  to  be  between 
fifty  and  sixty  years.  Appraisers  will  allow  a  rating  of 
first  class  on  a  steel  vessel  for  twenty  years,  and  if  certain 
requirements  are  complied  with,  the  period  is  extended.  And 
as  the  bonds  usually  mature  in  ten  years  and  are  retired  serially, 
the  equity  of  the  security  is  never  endangered  on  a  steel  vessel, 
as  long  as  the  vessel  is  kept  in  good  repair.  Every  mortgage 
deed  should  consequently  provide  that  the  vessel  shall  be  kept 
in  good  repair  (and  any  violation  of  the  requirements  shall  be 
made  a  forfeiture  of  the  mortgage).  The  condition  of  the 
vessel  should  regularly  be  made  known  to  the  trustees. 

Financial  Status. — The  careful  restrictions  of  the  mortgage 
deed  of  lake  steamer  issues  and  the  care  with  which  they  have 
been  supervised,  due  to  the  influence  of  the  Michigan  and  Ohio 
laws,  have  largely  offset  the  meagre  information  the  investors 


450  INVESTMENT  ANALYSIS 

in  these  bonds  have  had  concerning  the  financial  status  of  their 
equities.  On  the  other  hand,  had  the  full  and  complete  finan- 
cial status  of  certain  ocean-steamship  companies  been  known, 
their  securities  would  not  have  found  the  ready  market  they 
have.  It  probably  could  be  said,  however,  that  had  the  guard- 
ianship of  these  particular  companies  been  the  same  as  that 
assigned  to  the  trustees  of  the  lake  steamship  companies,  the 
general  information  given  would  have  been  sufficient.  Never- 
theless, there  seems  to  be  no  reason  for  believing  that  giving 
publicity  to  a  sound  financial  policy  can  work  an  injury  to  a 
corporation. 

Over-capitalization  in  the  Great  Lakes  steamship  corpora- 
tions has  never  been  an  issue.  The  bonded  debt  has  never  ex- 
ceeded 50  per  cent  of  the  value  of  a  new  vessel,  the  other  one- 
half  being  paid  by  the  stockholders  in  capital  stock,  so  that  no 
fictitious  values  have  existed  in  the  valuations  of  these  vessels. 
Temporary  obligations  are  always  limited  to  a  fixed  sum  or  to  a 
certain  percentage  of  the  bonds.  The  most  frequent  fixed 
amount  is  $1,000  or  5  per  cent  of  the  authorized  amount  of  the 
bond  issue.  These  regulations  are  unknown  to  ocean  steam- 
ships as  a  class. 

The  trustee  should  receive  a  quarterly  detailed  statement  of 
earnings  and  expenses  and  a  balance  sheet,  in  order  that  he 
may  know,  whether  the  requirements  of  the  mortgage  deed  are 
being  fulfilled.  As  both  interest  and  one-tenth  (in  a  ten-year 
issue)  of  the  principal  must  be  retired  annually,  the  margin 
of  safety  in  earnings  must  essentially  be  larger  than  if  interest 
alone  were  to  be  met. 

Trust  Deed. — The  trust  deeds  of  lake  steamship  bonds  have 
been  standardized  by  the  requirements  of  the  Michigan  and 
Ohio  savings  banks  laws,  and  as  a  consequence  a  large  part  of 
the  securities  are  taken  within  this  territory.  This  is  not  true 
of  the  ocean  steamships.  Considerable  variations  are  found 
among  the  mortgage  deeds  of  these  companies,  the  majority  of 
which  place  greater  restrictions  on  the  powers  of  their  trustees, 
than  do  the  lake  steamer  companies. 

No  mortgage  deed  should  be  accepted  by  an  investor  unless 
it  is  either  on  a  freight  or  freight  and  passenger  steamship.  The 


GREAT  LAKES  STEAMSHIP  451 

preponderance  of  earnings  from  freight  revenue  makes  the 
reason  for  this  obvious.  "Wooden  vessels  should  never  be 
accepted  as  security,  excepting  where  they  constitute  a  frac- 
tional part  of  a  fleet.  Where  it  is  necessary  to  determine  the 
size  of  the  vessel  it  will  be  safe  to  accept  as  a  guide  the  Michi- 
gan and  Ohio  laws,  which  limit  the  size  to  a  minimum  of  five 
thousand  tons.  Where  bonds  are  issued  on  a  single  vessel, 
the  vessel  should  never  be  more  than  five  to  eight  years 
old,  although  if  the  issue  were  made  on  a  fleet  with  two  or  more 
new  vessels,  an  older  vessel  might  be  included  if  the  margin  of 
the  equity  behind  the  bond  were  proportionately  increased. 

The  most  important  single  regulation  covering  all  possible 
risks  of  losses  to  the  vessel  is  the  insurance  clause  (which  will 
be  described  in  a  following  section).  The  power  of  the  trustee 
to  enforce  the  regulations  of  the  insurance  clause  should  be 
quite  absolute,  as  the  sole  equity  is  in  the  vessel  itself.  To 
allow  insurance  to  be  taken  out  in  questionable  companies,  or 
the  premiums  to  lapse  for  a  week,  or  the  vessel  to  make  a  voy- 
age after  the  open  season,  might  result  in  the  whole  equity  being 
destroyed  if  a  maritime  storm  or  fire  should  occur.  All  other 
claims  that  might  arise  against  the  vessel,  such  as  mechanics' 
liens,  admiralty,  statutory  or  other  liens  or  claims,  should  be 
immediately  settled  by  the  mortgagee,  for  the  failure  to  do  this 
constitutes  a  default. 

Current  obligations  should  never  exceed  5  to  7  per  cent  of 
the  original  amount  of  the  mortgage.  A  failure  to  regulate 
current  obligations  would  destroy  the  effectiveness  of  the  com- 
pany's serial  retirement  and  the  increase  in  the  equity  of  the 
funded  obligations.  And  these  current  obligations  might  be  of 
such  a  character  that  they  would  have  priority  to  any  other 
claims.  Again,  failure  to  comply  with  these  limitations  could 
be  made  grounds  for  defalcation  by  the  mortgagee. 

All  lake  steamship  bonds  are  redeemed  in  serial  payments, 
while  the  majority  of  the  ocean-going  vessels  have  the  sinking 
fund  provisions.  There  is  no  question  that  the  serial  payment 
is  the  only  dependable  method  of  redemption  for  steamship 
bonds.  Practically  all  of  the  outstanding  bonds  mature  in  ten 
annual  payments.  Seldom  should  the  duration  of  these  bonds 


452  INVESTMENT  ANALYSIS 

extend  beyond  fifteen  years,  because  the  first-class  insurance 
ratings  of  vessels  are  for  twenty  years,  and  a  sufficient  margin 
should  be  allowed,  and  also  because  it  is  a  safer  guarantee 
against  the  losses  that  might  occur  from  changing  conditions 
affecting  water  transportation. 

Insurance. — Particular  care  should  be  taken  that  all  possible 
losses  which  in  any  way  might  affect  the  equity  of  the  bond- 
holder are  fully  protected  by  insurance.  The  risks  involved  in 
maritime  business  are  relatively  much  larger  than  those  in  any 
other  type  of  corporation,  especially  where  a  bond  issue  is  made 
on  one  vessel.  Even  a  company  having  vessels  scattered  in 
various  lake  ports  may  suffer  heavy  loss  should  a  wide-spread 
maritime  storm  occur.  Without  a  sufficient  amount  of  insur- 
ance to  cover  all  losses,  a  ship  bond  can  only  have  a  very  highly 
speculative  value  and  should  be  entirely  eliminated  from  the 
investment  class. 

The  insurance  companies'  forms  and  the  respective  amounts 
of  all  policies  should  be  approved,  and  assigned  as  collateral 
security  to  the  trustee  in  case  of  loss  by  indemnity  or  destruc- 
tion of  property  during  the  life  of  the  bonds.  The  trustee 
should  be  further  empowered  to  prosecute  and  bring  any  nec- 
essary action  in  the  courts,  "to  recover  any  and  all  insurance 
moneys  which  may  become  due  and  payable  under  any  of  said 
policies  of  insurance."  The  amount  of  the  insurance  should 
be  a  much  larger  proportion  of  the  value  of  a  single  vessel  than 
of  a  fleet,  as  the  risk  involved  in  the  former,  other  things  being 
equal,  is  much  larger  than  in  the  latter.  Most  authorities 
maintain  that  the  insurance  on  a  single  boat  should  be  no  less 
than  twenty-five  per  cent  greater  than  the  amount  of  the  bonds 
outstanding.  But  the  larger  risk  involved,  in  the  security  of 
bonds  on  a  single  vessel,  as  compared  to  the  bonds  on  a  fleet,  is 
so  apparent  that  it  needs  no  discussion. 

Further,  the  insurance  should  provide  in  detail  that  all 
"vessel  property"  covered  by  the  mortgage  "should  be  insured 
against  loss  by  fire,  and  against  all  marine  risks  and  disasters, 
general  and  particular  average  and  collision  liability  including 


'Mortgage  Deed  of  Vulcan  Steamship  Company  (dated  Jan.  1,  1907). 


GREAT  LAKES  STEAMSHIP  453 

also  protection  and  indemnity  insurance  (on  form,  covering, 
among  other  things,  liability  for  injuries  to  persons.)"1  .  .  . 
"That  it  [the  steamship  company]  will  navigate  said  vessel  at 
all  times  in  strict  accordance  with  the  terms  of  said  insurance 
policies,  complying  with  all  the  provisions  thereof,  and,  that 
prior  to  the  close  of  the  season  of  navigation  and  prior  to  the 
time  limit  in  said  policies  for  the  expiration  of  the  maritime 
insurance  covered,  it  will  lay  up  said  vessel  in  accordance  with 
the  terms  of  said  policy  or  policies  so  that  the  same  shall  always 
be  kept  in  full  force  and  effect"  and  the  trustee  in  this  par- 
ticular case  must  be  given  proper  notification  of  all  of  these 
acts.2 

Michigan  and  Ohio  Laws. — The  state  savings  banks  of  thir- 
teen states  will  allow  the  investment  of  state  savings  banks 
funds  in  steamship  securities,  if  certain  statutory  requirements 
are  fulfilled.3  Seventeen  states  according  to  the  state  banking 
commissioners  of  these  states  deny  savings  banks  the  right  of 
investing  in  these  securities  on  the  basis  of  the  existing  statutes.* 
The  Michigan  and  Ohio  laws  are  the  only  specific  statutes  gov- 
erning the  purchase  of  steamship  securities  of  the  Great  Lakes. 
These  statutes  are  so  well  drawn  up  that  the  savings  banks  of 
these  states  have  never  suffered  any  losses.  Further,  these 
laws,  which  grew  out  of  the  demands  of  the  conservative 
bankers,  have  been  largely  instrumental  in  forcing  all  the 
securities  issued  by  companies  in  the  Great  Lakes  regions  to 
comply  with  the  requirements  of  these  laws.  Both  the  Ohio 
and  the  Michigan  laws  require  that  the  mortgages  shall  be 
upon  lake  steamers  carrying  freight  or  passengers  and  freight, 
but  not  on  vessels  carrying  passengers  alone.  The  minimum 
tonnage  capacity  in  both  cases  is  5,000  tons.  While  the  Ohio 


Trom  Mortgage  Deed  of  the  Cleveland  and  Buffalo  Transit  Co. 
(dated  Jan.  1,  1913),  Article  II. 

2Vulcan  Steamship  Mortgage  Deed,  Ibid. 

'The  following  list  of  states  under  notes  1  and  2  was  secured  through 
correspondence  with  the  savings  banks  departments  of  these  respective 
states :  Maine,  Virginia,  Delaware,  Maryland,  Iowa,  Michigan.  Ohio, 
Kentucky,  Louisiana,  Alabama,  South  Dakota,  Utah  and  Washington. 

'Connecticut,  New  Jersey,  Vermont,  New  Hampshire,  New  York, 
Massachusetts,  Kansas,  Minnesota,  Illinois,  Missouri,  Wisconsin,  Ar- 
kansas, Texas,  Oklahoma,  Wyoming,  Idaho  and  California. 


454  INVESTMENT  ANALYSIS 

law  permits  a  bond  issue  to  be  made  on  a  vessel  five  years 
after  its  completion  and  entrance  into  service,  the  Michigan 
law  allows  a  lapse  of  only  one  year. 

In  both  states  the  mortgage  must  not  exceed  50  per  cent  of 
the  original  cost  of  the  vessel.  The  requirement  of  the  annual 
retirement  of  ten  per  cent  of  the  principal  beginning  within 
two  years  after  the  issuing  date  of  the  bonds  and  the  limitation 
of  current  obligations  to  five  per  cent  of  the  original  principal 
of  the  bonds  issued  are  similar.  Both  laws  provide  that  the 
owners  of  the  vessel  or  vessels  shall  purchase  insurance  to 
their  full  insurable  value  to  cover  all  risks,  and  all  policies  are 
to  be  approved  by  the  trustee.  A  schedule  of  these  policies 
signed  by  the  trustee  shall  be  filed  with  the  state  savings  bank 
department.  Likewise,  the  payment  for  losses  by  the  insur- 
ance company  and  the  method  of  distributing  these  incomes 
must  be  reported  in  a  similar  manner  by  the  trustee. 

Denomination,  Duration  and  Yield. — The  denominations  of 
steamship  bonds  are  more  frequently  in  the  $1,000  series,  though 
a  number  of  $500  denominations  are  outstanding.  Despite  the 
general  sentiment  against  these  securities,  the  limited  amount 
and  the  eagerness  with  which  the  issues  are  taken  up  in  the  lake 
ports  have  made  them  as  acceptable  as  railroad  bonds.  Hence, 
the  bankers  have  not  had  to  make  an  appeal  to  the  small  in- 
vestor. The  majority  of  the  serial  bonds  prior  to  1916  were 
issued  at  par  on  a  five  per  cent  nominal  rate,  though  a  few  of 
the  smaller  companies  sold  on  a  six  per  cent  basis.  The  lake 
steamship  bonds  are  usually  issued  in  serial  form  with  a  dura- 
tion of  ten  years.  The  proportionate  retirement  and  increasing 
equity  of  the  serial  bonds  have  been  important  factors  in 
placing  steamship  bonds  on  such  a  high  plane. 


CHAPTER  XXVI 
INDUSTRIAL  BONDS 

Character  and  Size  of  Business.1 — The  wide  field  embraced 
by  industrials  and  the  many  and  varied  influences  which  affect 
the  different  types  of  industrials,  necessitate  a  general  classifi- 
cation not  only  of  each  industry,  but  often  of  a  particular 
branch  of  a  single  industry.  Even  to  classify,  for  .example,  all 
companies  manufacturing  machinery  under  one  head  and  to 
analyze  them  on  the  same  basis,  would  frequently  lead  to 
erroneous  conclusions.  A  company  which  manufactures  small 
machinery  and  extends  short  time  credit  would  adopt  an  en- 
tirely different  financial  policy  from  that  of  a  company  pro- 
ducing heavy  machinery  on  longer  time  credit.  Again  certain 
types  of  industries,  such  as  the  clothing  business,  respond  more 
quickly  than  others  to  periods  of  industrial  and  commercial 
depression.  These  industries  are  usually  forced  to  cut  prices 
in  an  attempt  to  retain  their  trade,  in  order  to  meet  fixed 
expenditures. 

Considerable  differences  also  exist  between  the  manufac- 
turers of  partly  finished  and  finished  products,  and  between  the 
manufacturers  of  necessities  and  luxuries.  Though  the  pro- 
ducers of  the  staple  food  stuffs  will  be  more  or  less  affected 
during  a  period  of  stringency,  they  will  not  be  to  nearly  the 
same  extent  as  manufacturers  of  ornamental  trinkets.  A  com- 
pany manufacturing  a  highly  specialized  article  that  is  subject 
to  the  whim  of  fashion  may  also  find  itself  in  a  precarious  posi- 
tion, unless  the  plant  can  be  converted  quickly  to  another  use. 
This  is  not  true  of  companies  manufacturing  products  for  which 
a  day  to  day  demand  exists.  Such  corporations,  for  example,  as 
soap  and  cracker  makers  prosper  because  of  the  steady  buying 


'The  character  of  the  management  and  control  particularly  apply  to 
industrial  corporations.    See  chap,  iv  for  a  discussion  of  this  topic. 

455 


456  INVESTMENT  ANALYSIS 

demand.  Industries,  such  as  the  manufacture  of  automobile 
products  which  in  part  can  be  classed  as  a  luxury  or  necessity, 
must  be  checked  even  more  closely  to  discover  the  effect  of 
fluctuating  market  conditions  on  the  earnings.  The  rapid 
growth  in  the  use  of  the  automobile  and  the  truck  has  until 
recently  largely  offset  any  reactionary  influences.  Eventually, 
the  industry  will  settle  to  a  normal  growth,  and  like  the  shoe 
industry,  shift  from  a  speculative  to  a  well-established  basis  and 
consequently  yield  a  more  constant  rate  of  return.  A  fad 
quickly  developed  for  bicycle  riding  just  before  the  automobile 
became  commercially  practical,  and  in  five  years  a  large  bicycle 
industry  was  established.  "With  the  increasing  use  of  the  auto- 
mobile, the  major  part  of  the  demand  for  bicycles  disappeared 
as  quickly  as  it  had  developed.  The  manufacturers  who  were 
not  shrewd  enough  to  anticipate  this  almost  entire  temporary 
stoppage  of  the  bicycle  business  were  forced  into  receivership. 

Industrials  tend  to  vary  in  efficiency  with  the  size  of  the 
organization.  In  many  cases  unusual  efficiency  is  obtained  in 
the  large  enterprises,  yet  the  United  States  Steel  Corporation 
in  its  brief  before  the  United  States  District  Court,  maintained 
that  there  is  a  limitation  of  efficiency  in  large  scale  production.1 
Greater  efficiency  in  the  operation  of  a  small  plant  has  often 
offset  the  advantages  normally  accruing  to  large  scale  organi- 
zation. 

While  there  is  other  evidence  indicating  the  necessity  of  a 
qualified  acceptance  of  the  continuing  advantages  of  ever- 
increasing  large  scale  production,  there  is  no  question  but  that 
the  average  well  managed  large  corporation  has  a  decided  finan- 
cial advantage.  To  the  investor,  this  is  of  the  more  immediate 
importance.  The  banker  can  offer  more  advantageous  terms 
on  the  large  loans  needed  for  corporate  purposes  by  a  large 
corporation,  other  things  being  equal,  than  he  can  to  the  smaller 
corporation  with  its  less  easily  negotiable  loans. 

Competition. — Eailroads  and  street  railways  are  at  least 
limited  monopolies,  but  few  industrials  are  ever  free  from  com- 
petition. An  industrial  corporation  manager  putting  out  a 


United  States  Supreme  Court  Decision,  1920. 


INDUSTRIAL  BONDS  457 

single  product  may  waken  to  find  that  overnight  some  new 
process  (which  will  entirely  displace  his  own)  has  been  in- 
vented. The  success  of  a  great  advertising  campaign,  an  advan- 
tage in  locality,  replacement  by  superior  patents,  and  a  score  or 
more  of  new  and  shifting  conditions  often  create  competition 
that  makes  serious  inroads  into  a  corporation's  profits. 

The  change  of  a  freight  rate  or  the  strict  enforcement  of  the 
long  and  short  haul  clause,  may  deprive  the  corporation  of  a 
part  at  least  of  the  advantages  of  location  and  check  the  devel- 
opment of  a  company  that  would  otherwise  give  great  promise. 
A  more  cleverly  devised  campaign  of  advertising  may  be  suffi- 
cient to  turn  the  tide  of  customers  to  another  company. 
Superior  purchasing  ability,  a  better  quality  of  goods,  a  more 
acceptable  handling  of  customers,  a  better  method  of  delivery, 
a  greater  elasticity  in  credit,  etc.,  these  separately  or  combined 
may  turn  the  tide;  and  such  is  the  psychology  of  the  crowd, 
that  often  fashion's  stamp  of  approval  is  enough  to  control 
the  market. 

Even  the  United  States  Steel  Corporation1  has  not  retained 
the  measure  of  control  of  the  steel  market  it  first  possessed.  Its 
almost  complete  control  of  ore  supply  only  stimulated  to  greater 
endeavor  the  efforts  of  its  rivals  in  the  discovery  of  new  sup- 
plies. The  first  great  leather  combination,  the  United  States 
Leather  Company,  at  the  time  of  its  organization  failed  to  con- 
sider that  under  the  old  process  then  in  use  hides  could  be 
tanned  in  small  quantities  as  cheaply  as  in  large  quantities,  and 
competition  soon  forced  reorganization.  The  competition  in 
the  manufacture  of  heavy  reciprocating  engines  which  was  the 
principal  type  of  engine  manufactured  by  the  old  Allis  Chal- 
mer's  Company  greatly  hastened  the  reorganization  of  that 
corporation.  The  difficulties  to  be  overcome  in  acquiring  con- 
trol of  any  large  corporation  are  measures  in  themselves  of  the 
stability  and  security  of  a  corporation's  market. 


1See  such  works  as  A.  Cotter's  The  Authentic  History  of  the  United 
States  Steel  Corporation  (1916)  ;  United  States,  United  States  Steel 
Hearings,  62nd  Congress  1st  session,  and  United  States  Supreme  Court 
Case.  1921 ;  Abraham  Berglund,  The  United  States  Steel  Corporation 
(1907). 


458  INVESTMENT  ANALYSIS 

Except  for  short  term  bonds,  patents  do  not  always  offer 
sound  security.  With  the  great  number  of  patents  existing, 
there  is  always  the  danger  of  infringement  and  contest  in 
the  courts.  If  a  contest  is  likely  to  arise,  this  fact  at  once 
places  the  corporation  in  the  speculative  class.  For  illus- 
tration, the  owners  of  the  Taylor- White  process  for  making 
steel  tools,  who  had  received  a  very  large  income  from  their 
monopoly  for  a  number  of  years,  found  that  by  order  of  the 
court  their  process  could  not  be  patented.  Danger  lies  in  new 
inventions  and  processes,  for  other  corporations  are  always 
ready  to  attack  the  rights  of  a  patent,  especially  if  it  bears  any 
resemblance  to  an  existing  patent.  The  possibility  of  a  new 
patent  or  process  which  can  be  substituted  for  the  old,  prob- 
ably offers  the  greatest  danger  in  the  control  of  the  existing 
market.  With  the  kodak  patents,  certain  automobile  devices, 
and  harvest  machinery,  the  contrary  has  been  true,  and  the 
patents  have  been  worth  millions;  but  these  cases  are  so  few 
in  number  that  they  are  easily  catalogued.1 

The  reader  must  not  infer  that  in  speaking  of  these  numer- 
ous drawbacks  existing  in  industrial  corporations,  the  writer 
would  make  a  wholesale  condemnation  of  all  industrial  enter* 
prises.  In  fact,  splendid  opportunities  are  available  in  indus- 
trial bonds,  but  great  care  should  be  exercised  in  their 
selection. 

Management.2 — In  no  one  of  the  businesses  discussed  in  this 
volume  is  the.  question  of  management  so  important  as  in  indus- 
trials. A  complete  chapter  might  well  be  devoted  to  this  sub- 
ject. Even  in  the  well  established  industrials  of  today,  no 
great  industrial  corporation  can  be  named  which  does  not  at 
once  suggest  the  name  of  an  industrial  leader.  In  a  railroad 
organization,  because  of  the  high  standardization,  it  is  easy  to 
transfer  men  from  one  system  to  another  without  seriously 
affecting  operations.  A  shift  of  an  important  person  in  an 
industrial  organization  often  leads  to  serious  consequences.  The 


Edward  Sherwood  Meade,  The  Careful  Investor  (1914),  pp.  206-222. 
(This  chapter  is  devoted  to  a  discussion  of  the  security  based  upon 
Patents  and  Monopoly  Control.) 

'See  chap,  iv,  Topic  on  Management.  Control  and  Organization. 


INDUSTRIAL  BONDS  459 

problems  of  management  are  so  diversified  in  this  class  of 
corporations  that  any  standardization  must  have  decided  limi- 
tations. On  the  other  hand,  an  investor  should  always  be  wary 
of  the  long  termed  bonds  on  a  "single-man  controlled  organi- 
zation." An  organization  entirely  dependent  upon  one  man, 
sooner  or  later  meets  serious  difficulties.  As  this  book  goes 
to  press,  there  is  a  corporation  of  international  reputation 
which  is  in  this  very  predicament,  because  of  its  one  man  control 
and  the  failure  of  this  man  to  recognize  the  supreme  value 
to  a  corporation  of  a  well-rounded  and  strongly  "manned 
organization."  To  the  investor  in  long  termed  industrials,  a 
differentiation  between  these  two  types  of  management  is  most 
essential. 

Fixed  Property  Accounts? — The  items  entering  into  the 
fixed  property  accounts  of  industrials — land,  buildings  and 
equipment,  should  be  given  separately,  but  unfortunately  very 
few  corporations,  even  with  the  more  complete  reports,  sub- 
divide properly  the  items  on  the  balance  sheet. 

If  the  ground  value  of  a  corporation's  real  estate  has  been 
conservatively  appraised  and  is  highly  marketable  for  general 
business  use,  mortgage  bonds  based  thereon  should  be  perfectly 
safe.  Such  an  appraisal  figure  would  not  necessarily  agree 
with  the  valuation  appearing  on  the  balance  sheet,  which  should 
be  at  cost.  Of  course,  it  is  desirable  that  unimproved  and  un- 
used property  be  stated  separately.  Titles  should  be  above 
question. 

If  any  part  of  the  property  is  leased  and  the  lease  is  part 
of  the  security  for  funded  debt,  a  sinking  fund  should  be 
provided  to  take  care  of  the  diminishing  value. 

All  buildings  and  equipment  should  be  amply  covered  by  fire 
insurance  to  protect  the  business — and  the  security  holder — 
against  unnecessary  loss.  This  insurance,  if  possible,  should 
cover  both  physical  and  business  losses.  The  latter  is  written 


JIn  connection  with  the  topics  in  this  chapter  on  Fixed  Property 
Account,  Depreciation  and  Working  Capital  review  the  subject  matter 
in  chap.  ix.  Some  duplication  will  be  found  of  the  material  in  this 
chapter,  but  it  is  thought  best  to  treat  the  material  consecutively  despite 
the  duplication. 


460  INVESTMENT  ANALYSIS 

only  for  the  very  highest  type  of  industrial  corporation,  owing 
to  the  moral  risk  involved  during  dull  periods. 

Depreciation. — Equipment  and  buildings  should  be  carried 
at  cost  with  a  sufficient  reserve  to  cover  depreciation.  No  gen- 
eral rule,  as  is  intimated  under  the  general  discussion  of  depre- 
ciation,1 can  be  adopted  to  cover  any  particular  plant.  Ma- 
chinery is  very  much  better  taken  care  of  by  some  organizations 
than  by  others,  and  this  care,  of  course,  lengthens  its  life.  But 
with  the  average  business  the  general  rate  of  depreciation 
applied  to  that  class  of  industry  as  a  whole,  will  be  a  close 
enough  approximation  for  its  acceptance  in  the  investor's 
analysis. 

A  sound  analysis  of  the  financial  condition  of  any  cor- 
poration should  clearly  distinguish  between  capital  and. reve- 
nues. The  failure  to  do  so  confuses  investment  and  income. 
Until  recently,  but  a  very  limited  number  of  industrials  took 
cognizance  of  this  in  their  financial  policy.  As  a  result,  time 
and  again  corporations  have  paid  out  in  dividends,  earnings 
that  should  have  been  charged  to  offset  the  depreciation  of  the 
plant  or  equipment.  Though  the  effect  of  efficiency  and  depre- 
ciation must  be  differentiated  and  a  failure  to  allow  correctly 
for  depreciation  may  not  affect  efficiency  on  the  same  pro  rata 
basis,  it  may  become  a  very  serious  impairment  to  efficiency  in 
certain  lines  of  industry.  Sooner  or  later,  obsolescence  or  in- 
adequacy will  force  a  replacement.  If  provisions  for  deprecia- 
tion have  not  been  made,  existing  book  values  will  be  mis- 
leading. 

Even  where  depreciation  has  been  considered,  corporations 
have  very  frequently  followed  no  definite  policy,  other  than 
making  allowances  on  the  basis  of  ' '  fat  and  lean  years. ' '  "Where 
gross  income  fluctuates  in  comparatively  narrow  limits,  and  at 
somewhat  equally  measured  intervals,  such  a  method  will  givo 
a  fairly  true  portrayal  of  plant  values.  But  where  the  fluctua- 
tions are  wide,  irregular  and  especially  at  long  intervals,  or 
where  allowances  are  made  at  pleasure,  plant  values  as  repre- 
sented by  the  bookkeeper  may  be  largely  fictitious.  The 

'Chap,  v. 


INDUSTRIAL  BONDS  461 

accepted  accounting  methods  and  regulation  requirements  of 
railroads  have  almost  eliminated  difficulties  of  this  kind  in  these 
corporations;  but  the  non-acceptance  of  sound  accounting  by 
many  industrial  corporations  has  resulted  in  many  questionable 
conclusions  being  drawn  from  these  data. 

Maintenance. — While  maintenance  as  an  account  is  differ- 
ent from  depreciation,  the  source  for  its  provision  should  be 
the  same,  namely,  a  charge  against  operation.  Weak  corpora- 
tions find  maintenance,  next  to  depreciation,  the  easiest  item  to 
neglect  in  their  accounts.  The  immediate  effects  of  skimping 
maintenance  may  not  be  so  serious,  but  ultimately  the  operating 
efficiency  of  the  plant  must  suffer  and  physical  depreciation  be 
greatly  accelerated. 

On  the  other  hand,  outlays,  for  additions  to  the  plant  are 
sometimes  systematically  concealed,  being  charged  to  the  main- 
tenance account  which  virtually  turns  part  of  this  account  into 
a  secret  reserve.  Where  an  inside  controlling  interest  has 
desired  to  conceal  the  amount  of  current  earnings  from  the 
minority  holders,  surcharging  the  maintenance  account  has 
often  been  resorted  to.  This  practice  of  concealing  earnings 
under  the  cloak  of  depreciation  or  maintenance  may  cause  a 
sagging  of  the  security  price,  and  enable  the  controlling  inter- 
ests to  acquire  securities  at  low  prices  but  to  the  loss  of  the 
deceived  minority  security  holders. 

Goodwill. — "Goodwill  as  defined  by  one  author  is  an  im- 
material or  intangible  asset  which  represents  the  value  of  su- 
perior organization,  high  reputation,  advantageous  location,  or 
any  other  circumstance  which  gives  greater  carrying  power  to 
a  business  than  ordinary  returns  upon  capital  cost  invested."1 
Normally,  then,  a  new  enterprise  should  seldom  have  any  good- 
will represented  in  its  accounts,  as  the  advantages  of  this  asset 
usually  can  only  be  reflected  in  the  earnings  of  a  growing  con- 
cern. But  a  new  organization  or  a  reorganization  growing  out 
of  receivership  frequently  evaluates  goodwill  on  the  basis  of 
estimated  earnings,  and  the  overly  sanguine  expectations  of 


'John  Bauer,  Reprint  from  The  Accountant   (England).  December 
13,  1913,  p.  2. 


462  INVESTMENT  ANALYSIS 

speculative  promoters  have  frequently  led  to  unrealized  antici- 
pations, resulting  in  long  continued  sagging  prices  of  the  secu- 
rities or  bankruptcy  of  the  corporation.  "Where  these  estimates 
are  realized  within  a  reasonable  time,  there  can  be  no  very 
serious  objection  to  giving  them  value,  as  they  are  added  proof 
of  the  efficiency  and  judgment  of  the  management.  But  only 
in  very  rare  instances  can  good  will  be  used  as  a  substitute 
for  property  equity  in  securing  a  bond  issue. 

"Where  the  necessary  earnings  of  a  corporation  have  the  nor- 
mal range  of  fluctuations,  the  valuation  of  goodwill  (as  far  as 
the  investor's  interests  are  concerned)  is  a  simple  matter.  If 
it  is  correctly  separated  from  other  property  accounts,  and  a 
fair  return  on  the  business  determined,  the  earnings  above  the 
amount  (at  the  determined  rate)  on  the  total  investments,  capi- 
talized, would  give  the  value  of  goodwill  on  the  basis  of  the 
going  concern.  Ample  margin  should  be  allowed,  as  in  the 
security  upon  fixed  property. 

Working  Capital.1 — The  condition  of  accounts  embodied 
under  working  capital,  reveal  to  a  large  extent  the  strength  or 
weakness  of  an  industrial  company.  The  lack  of  working  capi- 
tal has  been  the  most  frequent  cause  for  the  failure  of  indus- 
trial corporations,  and  it  is  always  a  temptation  for  the  man- 
agement to  use  this  working  capital  for  speculative  purposes, 
particularly  during  periods  of  inflation,  the  very  time  it  should 
be  most  zealously  guarded.  Great  danger  exists  to  the  corpora- 
tion which  weakens  its  working  capital  through  payment  of 
unjustified  dividends  or  through  over-expansion  in  the  accumu- 
lation of  inventories,  such  as  existed  in  many  industrial  cor- 
porations at  the  end  of  1920. 

Theoretical  working  capital  as  herein  defined,  may  have 
been  the  same  for  a  company  in  1920  as  in  1914,  even  though 
the  inventories  increased  into  the  millions  and  were  offset 


1  "Working  capital  or  Net  Current  Assets  are  the  net  free  quick 
assets  of  a  corporation,  not  usually  given  on  a  balance  sheet  found  by 
subtracting  current  liabilities  from  current  assets."  Clinton  Colver. 
How  to  Analyze  Industrial  Securities  (1919),  p.  153. 

The  term  working  capital  is  loosely  used  and  the  reader  should  con- 
stantly watch  the  sense  in  which  the  term  is  used.  Some  industrial 
circulars,  for  example,  refer  to  working  canital  as  the  amount  of  the 
total  current  assets. 


INDUSTKIAL  BONDS  463 

by  an  equivalent  increase  in  the  current  payables.  The 
detailed  examination  of  the  accounts,  however,  shows  an  entirely 
different  condition.  Goods  may  become  unsalable,  at  least  at 
anything  like  the  price  paid,  while  bills  payable  have  to  be  met. 
The  effect  of  this  may  be  disastrous.  In  other  words,  working 
capital  must  never  be  considered  apart  from  the  individual 
condition  of  both  current  assets  and  current  liabilities. 

After  the  amount  of  the  working  capital  funds  are  deter- 
mined for  any  company,  it  is  essential  to  find  out  first,  what  has 
been  the  policy  of  the  company  in  appropriating  funds  out  of 
current  income  to  meet  an  expanding  need  of  working  capital. 
These  funds  may  come  from  the  issue  of  bonds  and  stocks, 
from  commercial  credit  or  from  current  earnings.  If  the 
needed  appropriations  have  come  from  the  last  named  over  a 
series  of  years,  the  company  will  normally  show  unusual 
strength.  While  stocks  or  both  bonds  and  stocks  must  be 
issued  in  the  initial  launching  of  a  company  or  in  a  large  im- 
mediate expansion,  the  continued  drawing  of  all  working  capi- 
tal from  the  outside  will  reflect  weaknesses  in  the  company.  A 
comparison  of  industrial  corporations  which  have  obtained 
working  funds  from  earnings,  with  others  which  have  freely 
issued  securities,  will  show  that  on  the  average  the  financial 
position  of  the  former  will  average  better,  and  the  price  of 
their  securities  will  reflect  the  influence  of  the  more  conserva- 
tive management. 

The  use  of  commercial  credit,  usually  necessary  at  certain 
times  of  each  year,  depends  entirely  upon  the  character  of  the 
company  and  upon  the  banking  connections  it  possesses.  When 
there  is  a  need  of  large  working  capital  during  only  a  few 
weeks  of  the  year,  there  is  unquestionably  a  decided  advan- 
tage in  securing  a  part  of  this  fund  from  the  banks.  The  im- 
portant consideration  here,  however,  is  not  only  whether  the 
corporation  is  strong  enough  to  receive  an  extension  of  credit, 
if  necessary,  but  also  whether  it  will  be  able  to  secure  the  funds 
in  a  strained  market.  While  one  corporation  may  fail  because 
its  banking  connections  are  not  strong  enough  for  it  to  obtain 
the  extension  of  a  loan,  another  corporation  will  weather  a 
strain  because  of  its  ability  to  secure  a  loan. 


464  INVESTMENT  ANALYSIS 

Another  important  consideration  in  the  analysis  of  work- 
ing capital  is  the  examination  of  the  individual  items  of  current 
accounts  in  industrial  corporations.  The  easiest  and  most 
effective  juggling  can  be  and  has  been  done  in  the  handling  of 
current  assets  and  liabilities.  The  greatest  abuse,  no  doubt, 
has  been  the  manipulation  of  inter-company  accounts  between 
the  subsidiaries  of  a  holding  company.  This  can  easily  be  done 
if  a  consolidated  income  statement  is  not  issued.  If  such  a 
statement  is  obtained,  as  well  as  the  individual  income  state- 
ments and  balance  sheets  of  the  subsidiaries,  it  is  not  a  difficult 
matter  to  acquire  the  ability  to  distinguish  the  relative  impor- 
tance of  the  current  accounts. 

Where  securities  are  held,  their  value  must  be  individually 
checked.  Securities  carried  as  the  assets  of  the  company  are 
often  those  of  subsidiary  companies.  They  should  be  carried  as 
fixed  assets  or  more  preferably  as  separate  accounts  and  not  as 
current  assets  as  some  companies  carry  them.  If  there  are 
large  security  holdings  of  outside  companies,  their  value  must 
be  determined;  first,  on  the  strength  of  the  issuing  company 
and  second,  on  their  convertibility.  For,  should  these  securities 
not  be  readily  convertible  without  sacrifice,  they  would  possess 
little  value  to  the  corporation  for  current  needs  which  might 
be  the  vital  thing  involved  here.  Only  readily  marketable 
securities,  not  connected  with  or  vital  to  a  corporation's  busi- 
ness, should  be  considered  among  current  asset  items,  if  con- 
servative practice  is  to  be  followed. 

If  the  stock  of  raw  materials  or  finished  products  is  large 
at  the  period  of  high  production,  conditions  are  normal;  but  a 
large  amount  of  finished  stock  at  the  end  of  the  important  sea- 
sonal sale  period  of  that  industry  indicates  a  decided  weakness. 
If  the  company  does  a  fairly  constant  business  and  is  not  sub- 
ject or  only  slightly  subject  to  seasonal  influences,  there  are 
usually  no  radical  changes  in  the  value  of  inventory  stocks, 
except  when  large  fluctuation  occurs  in  the  price  of  raw  prod- 
ucts and  a  company  takes  advantage  of  the  market  too  long,  or, 
on  the  other  hand,  suffers  from  a  sudden  decline  in  the  market 
values  of  goods  on  hand. 

Accounts  and  bills  receivable  vary  with  the  types  of  indus- 


INDUSTRIAL  BONDS  465 

try.  A  certain  company  manufacturing  heavy  farm  machinery 
must,  under  present  credit  policies,  carry  farm  notes  six 
months  or  more.  Certain  classes  of  food  products  companies, 
on  the  other  hand,  will  not  carry  receivables  more  than  fifteen 
to  thirty  days.  While  the  proper  allowance  should  be  made  for 
seasonal  fluctuations,  the  proportion  of  the  amount  of  these 
accounts  to  the  gross  sales  of  the  business  should  be  scrutinized 
carefully.  A  period  of  industrial  and  commercial  strain  may 
greatly  overburden  the  company  with  doubtful  accounts,  which 
are  misleading,  owing  to  the  fact  that  on  their  face  they  seem 
to  show  a  very  strong  position  in  quick  assets. 

The  variables  affecting  the  total  amount  of  working  capital 
and  earnings  are  then :  the  size  of  the  corporation  and  the 
volume  of  business,  the  variety  of  the  products,  the  expansion 
of  the  business,  the  conditions  affecting  the  supply  and  purchase 
of  raw  material,  the  seasonal  influences  on  the  business,  the 
steadiness  and  regularity  in  the  market  demand  for  the  product, 
the  terms  of  payment,  and  the  length  of  time  that  it  takes  to 
put  the  finished  product  on  the  market.1 

With  the  character  of  the  accounts  established,  the  ratio 
between  current  assets  and  current  liabilities  should  be  checked. 
Again  the  exact  ratio  depends  upon  the  type  of  business,  and  a 
complete  consideration  of  this  one  point  would  entail  a  more 
elaborate  and  detailed  discussion  than  can  be  given  in  an  ele- 
mentary text  book,  on  the  principles  of  investments.  It  is  suffi- 
cient here  to  follow  the  established  rule  of  this  text  in  merely 
pointing  out  the  principle.  Two  to  one  is  generally  considered 
a  fair  average  proportion,  though  some  companies  show  as  much 
as  six  to  one.  As  pointed  out  above,  exact  ratios  between  the 
items  of  working  capital  must  be  determined  by  the  character 
of  the  business  and  ratios  given  can  be  taken  only  as  general 
averages.  A  business  having  a  ratio  of  three  to  one  might  be  in 
a  very  much  stronger  position  than  another  having  a  ratio 
of  five  to  one. 

Sales,  Earnings,  and  Expenses. — The  net  revenues  of  an 
industrial  vary  with  the  volume  of  business,  the  prices  of  the 

'William  H.  Lough,  Corporation  Finance  (1909),  pp.  293-294;  Clin- 
ton Colver,  How  to  Analyse  Industrial  Securities  (1919),  pp.  153-156. 


466  INVESTMENT  ANALYSIS 

commodities,  and  the  cost  of  operation.1  The  sales  of  indus- 
trials are  always  subject  to  fluctuations.  A  period  of  depression 
will  normally  cause  a  falling  off  in  sales  which  will  usually 
vary  to  the  degree  the  commodities  produced,  are  essentials. 
Industrials,  with  a  few  rare  exceptions,  can  never  hope  to  attain 
the  stability  either  in  business  or  in  profits  possessed  by  most 
public  utility  companies. 

If  a  company  enjoys  for  a  few  years  a  fairly  consistent  in- 
crease in  business  and  in  net  earnings,  and  carefully  conserves 
its  resources — especially  if  it  keeps  its  net  quick  asset  position 
strong,  the  time  may  come  when  it  will  not  be  affected  seriously 
by  normal  fluctuations  in  earnings.  Its  savings,  like  that  of  a 
successful  and  prudent  individual,  will  act  as  a  balance  wheel 
to  carry  it  over  its  difficulties.2  Just  as  most  individuals  are 
seriously  affected  by  changing  general  conditions,  so  are  cor- 
porations, and  as  intimated  above,  industrials  particularly. 
Depressions  in  general  business,  such  as  in  1908,  1914,  and  1920, 
for  example,  bring  out  the  fact,  realized  by  few,  that  business 
and  net  earnings  in  periods  of  inflation  must  be  discounted. 

In  the  final  analysis,  earnings  are  the  criterion  of  value 
an4  this  means  earnings  not  of  one  or  two  years,  but  of  several 
including  at  least  one  year  of  general  depression.  If  a  com- 
pany's common  stock  holds  up  relatively  well  in  the  market 
when  most  stocks  are  falling  rapidly,  and  if  it  has  proven 
that  it  can  endure  the  strain  of  competition  during  dull  times 
when  competition  is  actual,  then  its  bonds  will  warrant  serious 
consideration. 


'The  source  of  "Income  from  Other  Sources,"  as  stated  in  chap,  v, 
should  be  specifically  enough  stated  to  prevent  its  confusion  with  income 
derived  from  actual  operations.  With  a  very  large  outside  income,  it 
would  be  a  simple  matter  to  conceal  deficiencies  in  operation,  and  regu- 
late to  a  certain  extent  the  fluctuations  in  earnings.  It  would  also  be 
an  easy  matter  for  the  same  purpose  to  transfer  the  income  of  sub- 
sidiaries, though  the  danger  of  this  is  obviated  by  consolidated  balance 
sheets  and  income  statements. 

The  disposition  of  net  profits  gives  another  clue  to  the  policy  of  man- 
agement. If  ample  margins  have  been  left  to  provide  for  regular 
but  lower  dividends,  rather  than  irregular  dividends,  though  higher 
dividends ;  this  policy  is  positive  evidence  of  conservative  management. 
And  any  company  which  does  not  create  a  surplus  out  of  earnings  upon 
some  fixed  basis  cannot  be  recommended  as  an  investment. 

*See  chap.  v. 


INDUSTRIAL  BONDS  467 

Further,  it  is  more  than  conceivable  that  companies  may  so 
fortify  themselves  through  conserving  net  quick  assets  during 
periods  of  liberal  earnings  that,  like  prosperous  farmers  in  the 
cotton  belt  or  in  the  "dry  farm"  areas,  they  can  maintain 
unassailable  solvency  during  any  period  of  depression  which 
they  may  reasonably  be  expected  to  encounter.  A  concrete 
example  is  the  steel  industry.  Steel  is  a  "prince  or  pauper" 
industry,  yet  certain  companies,  such  as  the  United  States  Steel 
Corporation  have  so  strengthened  themselves  financially  that 
their  bonds  continue  to  enjoy  high  regard  in  investment  mar- 
kets at  times  when  the  industry  seems  at  a  hopeless  standstill. 

However,  it  is  important  to  note  whether,  judged  over  a 
series  of  years,  net  earnings  in  comparison  to  sales  hold  up  well. 
Because  of  gradual  but  forced  reduction  of  prices  on  account  of 
merciless  competition,  many  a  company  having  bonds  well 
within  the  investment  classification  might  eventually  suffer 
seriously.  Under  such  conditions  only  such  companies  can 
expect  to  survive  as  can  produce  at  the  lowest  cost  per  unit  of 
output  and  are  exceedingly  strong  financially.  Yet  the  effect 
of  the  fluctuations  of  gross  earnings  may  be  very  different 
from  the  ultimate  effect  on  net  earnings.  One  company  may 
suffer  a  fall  of  five  points  in  net  to  every  five-point  decrease 
in  gross,  while  another  company  may  have  but  a  one-point  fall 
in  net  to  every  five-point  fall. 

Legal  Status  of  Industrial  Securities. — A  few  states  in  an 
effort  to  build  up  a  local  industry,  have  exempted  the  securities 
of  domestic  corporations  from  taxation  if  held  within  the  state. 
In  some  states  this  exemption  is  confined  to  stock  issues;  bonds 
remaining  fully  taxable.  Comparatively  few  investment  secu- 
rities of  large  corporations  are  affected  by  such  tax  exemption 
laws.  Moreover,  the  price  of  the  strictly  investment  security 
free  of  state  tax  is  almost  always  priced  in  the  market  to 
discount  the  advantage  it  enjoys. 

Except  in  three  states,  no  industrial  securities  are  legal  in- 
vestments for  savings  banks,  per  force  of  specific  laws.  A  num- 
ber of  western  states  leave  the  approval  of  securities  to  the  dis- 
cretion of  state  officials.  Other  states  specifically  bar  industrial 
bonds  from  the  savings  bank  class.  On  the  other  hand,  two  of 


468  INVESTMENT  ANALYSIS 

the  old  conservative  New  England  states,  Maine  and  New 
Hampshire,  have  laws  in  effect  which  make  provision  for  the 
admission  of  local  industrial  corporation  securities — complying, 
of  course,  with  special  requirements — to  the  coveted  status  of 
"legal  for  savings  banks." 

There  seem  to  be  no  good  reasons  why  certain  industrial 
bonds  should  not  be  legal  for  savings  bank  and  trust  funds  of 
all  states.  They  are  certainly  higher  grade  in  every  way  than 
certain  "legal"  railroad  issues.  About  the  only  recommenda- 
tion that  can  be  given  a  number  of  the  latter  is  that  the  inertia 
of  the  law  gives  them  special  privileges. 

Possibilities  in  Industrial  Bonds. — During  the  recent  tem- 
porary eclipse  of  railroad  and  public  utility  securities,  indus- 
trial securities  not  only  gained  their  rightful  place  as  invest- 
ments but  gained  prominence  as  a  class,  which  they  did  not 
deserve.  Investors  who  heretofore  had  confined  their  pur- 
chases to  the  highest  grade  railroad  and  public  utility  underly- 
ing bonds,  took  on  large  blocks  of  debenture  bonds  and  even 
preferred  stocks  of  unseasoned  and  highly  speculative  indus- 
trial corporations.  The  drastic  liquidation  of  1920  clearly  evi- 
denced the  folly  of  such  action. 

Securities  cannot  be  judged  by  classes.  No  other  security  is 
so  hopelessly  bad  as  a  bad  government  or  municipal  obligation. 
A  government,  municipal,  railroad,  public  utility,  or  industrial 
security  is  desirable  if  it  passes  the  acid  test  of  analysis. 

Owing  to  the  building  of  financial  strength  during  periods 
of  great  industrial  prosperity  many  high  grade  "instantly  mar- 
ketable industrial"  bonds  are  available  in  the  market.  Only 
such  should  be  considered  by  investors. 


CHAPTER  XXVII 
TIMBER  BONDS 

When  the  logging  and  milling  companies  were  small,  the 
capital  of  the  owners  or  the  amount  which  they  could  raise  on 
their  personal  credit  was  sufficient  to  produce  and  market  all 
of  their  products.  But  with  the  rapid  increase  in  consumption 
and  the  consequent  necessity  of  obtaining  large  tracts  of  timber, 
the  consolidation  of  the  logging,  milling,  and  manufacturing 
industries  soon  introduced  the  practice  of  making  bond  issues 
by  companies  which  desired  the  advantages  of  a  combination  of 
all  these  factors  in  production.  The  proceeds  from  these  bond 
issues  were  used  in  buying  new  tracts,  in  building  plants,  mills, 
railroads,  and  in  providing  equipment  for  marketing  the 
product. 

The  experience  of  timber  bonds  in  the  general  market  does 
not  extend  over  twenty-five  years;  and,  as  is  the  case  with  all 
new  securities,  the  large  returns  of  the  first  enterprises  stimu- 
lated speculative  underwriters  to  assume  unwarranted  risks. 
Another  group  of  underwriters  (fortunately  few),  through  a 
lack  of  understanding  or  a  disregard  of  the  fundamental  prin- 
ciples of  timber  securities,  frequently  allowed  an  over  issue  of 
securities  on  a  property.  These  conditions,  together  with  a  tem- 
porary slump  in  the  lumber  industry  at  times,  fortunately 
forced  rather  an  early  reaction  in  the  development  of  the  tim- 
ber security  market.  Unfortunately,  as  in  all  such  experiences, 
a  number  of  timber  bonds  which  are  classed  among  the  safest 
securities,  suffered  from  the  odium  of  this  unwarranted  specu- 
lation. 

Supply  and  Consumption  of  Timber. — The  timber  supply  of 
the  United  States  has  been  disappearing  at  an  alarming  rate, 
but  it  has  been  only  in  the  last  fifteen  years  that  the  general 
public  has  given  any  serious  attention  to  the  warning  of  the 

469 


470  INVESTMENT  ANALYSIS 

conservationists.  Parts  of  New  England  which  were  formerly 
covered  with  timber  have  been  stripped  of  their  virgin  forests. 
The  Great  Lakes  states  twenty  years  ago  passed  the  height  of 
their  production,  the  Southern  states  are  now  producing  at  their 
best,  and  the  Western  states  are  fast  entering  their  zenith.  In 
1880,  Michigan,  New  York,  Pennsylvania,  and  Missouri  supplied 
approximately  50  per  cent  of  the  lumber  cut.  Today,  they  are 
supplying  less  than  10  per  cent. 

No  attempt  of  any  consequence  has  been  made  to  abate  this 
rapid  exhaustion  of  the  timber  supply.  The  only  protection 
against  the  extermination  of  the  forests  has  been  the  few  small 
reserves  set  aside  by  the  United  States  government,  and  such 
small  attempts  as  the  Pennsylvania  Railroad  and  a  few  private 
corporations  have  made  by  planting  a  quick  growing  variety  of 
trees  for  use  as  ties.  A  prominent  timber  authority  states: 

"No  matter  how  soon  we  start  in  to  duplicate  our  timbered 
areas  by  restoration,  it  will  take  at  least  fifty  years  to  grow 
medium  sized  soft  wood  trees,  which  will  produce  only  low 
grade  lumber,  and  from  two  hundred  to  five  hundred  years  to 
obtain  large  high  grade  stock  from  the  same  trees,  and  the  more 
valuable  woods  .  ...  the  period  will  run  from  three  hundred 
to  two  thousand  years  to  attain  the  present  growth  of  these  old 
forests  .  .  .  and  to  plant  and  cultivate  for  the  shortest  period 
mentioned,  it  will  cost,  with  interest  on  the  investment  and  other 
carrying  charges,  $15  to  $20  per  thousand  stumpage  and  the 
yield  will  be  a  common  and  coarse  grade  of  lumber.  When  you 
go  beyond  that  period  for  harvesting,  you  make  the  operation 
practically  an  economic  impossibility."1 

The  cost  of  lumber  just  prior  to  the  War  was  approximately 
eight  times  what  it  was  in  1850.  In  1920  the  sawmills  of  the 
United  States  produced  more  than  twice  as  many  feet  of  lum- 
ber as  in  1900.  This,  however,  accounts  for  only  one-half  of 
the  timber  cut.  The  use,  for  example,  of  wood  pulp  has  more 
than  doubled  in  the  last  ten  years.  Ten  years  ago  the  United 
States  furnished  its  entire  supply  of  wood  pulp,  but  now  two- 
thirds  of  it  if,  imported. 

The  United  States  also  exports  building  timber  to  almost  all 


JJ.  D.  Lacy,  Address  before  the  Eighth  Annual  Convention  of  the 
National  Lumbermen's  Association. 


TIMBER  BONDS  471 

of  the  important  civilized  countries  of  the  world.  These  export", 
take  about  one-third  of  the  net  output  of  the  United  States. 
With  the  easier  access  of  the  Western  timber  area  to  the  Euro- 
pean market  by  way  of  the  Panama  Canal,  the  output  of  this 
Western  area  must  materially  increase  in  the  next  few  years. 
While  the  wood-pulp  supply  in  the  United  States  is  now  largely 
supplemented  by  the  imports  from  Canada,  the  standing  tim- 
ber of  Canada  has  been  greatly  overestimated.1  The  Canadian 
Government  now  estimates  her  standing  timber  to  be  approxi- 
mately one-third  that  of  the  United  States.  Too  little  is  known 
of  the  forests  of  South  America  to  estimate  their  ultimate  effect 
on  the  output  of  the  United  States. 

"The  forests,"  states  Gifford  Pinchot,  "are  being  cut  three 
times  faster  than  the  natural  growth.  I  estimate  that  in  forty 
years,  unless  something  radical  is  done  towards  the  conserva- 
tion of  this  resource,  the  commercial  forests  of  the  United  States 
will  be  gone. ' '  Authorities  have  variously  estimated  that  at  the 
present  rate  of  increase  of  consumption  the  timber  supply  in 
the  United  States  will  be  exhausted  in  from  twenty  to  seventy- 
five  years. 

Control  of  the  Timber  Supply. — The  concentration  in  the 
control  of  the  standing  timber  in  the  United  States  has  had  an 
important  bearing  upon  the  amount  of  securities  issued  in  this 
industry.  With  less  than  150  million  dollars  of  timber  bonds 
distributed  among  the  general  public,  and  the  industry  valued 
at  from  ten  to  fifteen  billions,  the  evidence  of  concentration  is 
apparent.  While  the  federal  government  has  been  unmindful 
of  the  depletion,  and  heedless  of  the  recommendations  of  the 
conservationists,  the  large  lumber  interests  have  been  fully 
aware  of  the  conditions  and  have  quietly  secured  control  of  the 
large  areas. 

While  concentration  of  control  has  been  severely  criticised 
from  the  public  viewpoint,  the  opposing  contentions  are  that  it 
has  resulted  in  more  than  compensating  advantages.  Concen- 
tration has  to  a  degree  meant  conservation  of  supply  through 

1  Archibald  Marshall,  the  Statist  Supplement  (London),  June  11, 
1911.  (Seventy-five  per  cent  of  the  available  timber  supply  in  Canada  is 
controlled  by  United  States  capital.) 


472  INVESTMENT  ANALYSIS 

the  checking  of  waste  in  the  cutting,  milling,  and  marketing  of 
timber.  In  early  days  the  industry  practiced  the  most  wanton 
waste.  Had  the  old  competitive  method  continued,  this  waste 
must  have  continued  to  a  much  larger  degree  than  it  does  under 
the  economies  of  large  control,  though  increased  prices  alone 
would,  of  course,  have  forced  increased  economies.  Large  con- 
centration of  timber  holdings  has  also  enabled  these  corpora- 
tions to  establish  mills  and  factories  for  producing  finished 
wood  materials  and  furniture,  with  the  result  that  there  has 
been  an  economizing  both  through  a  reduction  of  factory  costs, 
and  in  the  wholesale  and  retail  distribution. 

In  the  large  timber  areas  two  other  possible  means  of  tim- 
ber conservation  are  available,  which  would  result  in  great 
future  savings  to  the  people.  Self-preservation  will  probably 
ultimately  force  their  adoption.  A  few  companies  are  already 
experimenting  in  a  small  way.  First,  a  more  careful  selection  of 
the  timber  cut  might  be  made  and  the  timber  not  fully  devel- 
oped be  allowed  to  mature.  The  second,  and  the  more  practical 
method,  would  be  to  allow  for  a  depreciation  fund  out  of  earn- 
ings to  replant  the  cut  area.  Every  forester  realizes  that  if 
this  latter  policy  had  been  required  seventy-five  years  ago,  the 
United  States  would  not  now  be  facing  a  timber  famine.  But 
as  it  is  only  for  us  to  point  out  the  influence  of  these  conditions 
as  affecting  timber  values,  it  is  not  necessary  to  enlarge  on  this 
problem. 

Legal  Prerequisites. — Four  factors  which  are  peculiar  to  a 
timber  bond  mortgage  should  be  given  especial  consideration: 
first,  the  character  of  the  items  covered  by  the  mortgage;  sec- 
ond, the  ratio  of  the  mortgage  to  the  value  of  the  properties; 
third,  the  provisions  for  the  cutting  of  the  timber;  fourth,  the 
insurance  and  fire  risks,  which  will  be  covered  under  a  separate 
heading. 

First,  the  lien  of  a  timber  bond  is  practically  always  a  first 
mortgage.  A  second  lien,  except  in  rare  cases  where  the 
amounts  of  both  mortgages  are  small,  could  not  find  a  market, 
or  the  rate  of  interest  demanded  would  be  too  high  for  the  cor- 
poration to  carry.  The  mortgage  should  include  a  lien  on  the 
land,  timber,  and  all  appurtenances  thereon.  This  latter  item 


TIMBER  BONDS  473 

would  consist  of  such  items  as  railroads,  sawmills,  flumes,  and 
other  sawmill  and  lumbering  equipment,  all  of  which  should  in- 
dividually and  collectively  be  covered  by  the  mortgage.  A 
great  many  errors  have  resulted  in  titles  to  timber  land,  because 
of  the  confusion  and  the  lack  of  records  that  existed  in  the  early 
settlement  of  new  territory.  One  case  is  cited  of  the  omission 
of  thirty-six  mortgages,1  which  would  have  had  prior  claims  to 
the  bonds  had  they  not  been  discovered  by  the  attorney  of 
the  bankers.  Such  omissions  in  a  mortgage,  needless  to  say, 
would  impair  the  value  of  the  equity  behind  the  bonds.  While 
we  look  to  the  standing  timber  for  the  greater  part  of  the  value 
back  of  the  security,  there  are  other  items  that  may  materially 
affect  the  bond. 

In  some  of  the  older  and  smaller  issues  of  timber  bonds,  the 
lien  through  error  of  the  title  was  only  on  land  and  did  not 
include  the  timber.  In  these  latter  cases,  where  the  quality  of 
the  land  is  poor,  there  is  little  security  for  the  bondholder  in 
the  case  of  default.  The  very  remoteness  of  the  timber  acreage 
may  give  little  or  no  value  to  the  land  when  cleared.  Again,  if 
defalcation  of  the  issue  takes  place,  the  omission  of  land  values 
where  the  quality  of  the  land  is  good,  and  especially  if  it  is  on 
a  navigable  stream,  would  ultimately  remove  a  desirable  part 
of  the  security  that  might  offset  the  losses  involved  in  the  tim- 
ber holdings  due  to  foreclosure.  The  location  of  the  land,  there- 
fore, is  of  importance  in  enhancing  values,  not  only  in  the  rela- 
tion to  the  easy  marketing  of  lumber  which  would  reduce  the 
fixed  expenditures  on  the  properties  to  a  minimum,  but  also  in 
the  disposal  of  the  land  itself.  During  the  period  in  which  the 
flotation  of  timber  securities  was  at  its  height,  a  bond  house, 
in  examining  the  location  of  a  small  company  in  one  state, 
found  that  the  cost  of  bringing  the  lumber  to  the  nearest 
railroad  would  not  leave  sufficient  money  to  pay  the  bonded 
interest. 

If  the  timber  land  contains  a  navigable  stream  that  could 
furnish  water-power,  it  would  strengthen  the  company's  credit 


1Edward  E.  Barthell,  Timber  Bonds  as  Investments,  American  Acad- 
emy of  Political  and  Social  Science,  1912,  pp.  23-50. 


474  INVESTMENT  ANALYSIS 

position  if  this  power  could  be  used,  as  it  would  be  a  valuable 
addition  to  the  security  of  the  bonds.  The  value  of  this  item, 
of  course,  would  vary  according  to  the  location  of  the  tract,  as 
this  would  determine  whether  power  could  be  sold.  The  prop- 
erty also  has  increased  value  if  the  land  bears  minerals  in  pay- 
ing quantities,  and  the  by-products  of  timber,  as  tar,  pitch,  tur- 
pentine, bark,  tops,  etc.,  are  utilized. 

It  is  highly  undesirable  that  a  very  large  part  of  the  loan 
should  be  secured  by  plants,  mills,  or  other  equipment.  When 
the  timber  has  been  cut,  the  depreciation  equipment  accounts 
should  be  entirely  written  off,  this  equipment  having  no  value 
except  as  scrap.  The  equipment  is  usually  built  as  cheaply  as 
possible,  in  order  to  reduce  the  cost  of  the  output,  so  that  it  is 
usually  in  a  depreciated  condition  when  the  acreage  available 
to  the  sawmills  is  cleared.  "When  plants  are  located  within 
large  centers  like  Tacoma  and  Bellingham,  Washington,  and  the 
plant  is  covered  by  a  large  fire  risk  guaranteed  in  the  mort- 
gage, a  larger  ratio  of  the  plant  value  could  be  included  as 
security,  though  insurance  costs  are  usually  too  large  to  war- 
rant such,  expenditures,  excepting  where  the  plant  is  close 
enough  to  the  city  to  have  adequate  fire  protection.  Even  then 
the  charges  are  very  high. 

Secondly,  there  is  always  a  very  large  margin  required  be- 
tween the  amount  of  the  bond  issue  and  the  value  of  the  prop- 
erties. The  value  of  the  standing  timber  should  be  double  the 
outstanding  bond  issue,  and  many  authorities  would  claim  that 
the  land  should  be  included  in  this  valuation.  In  practice  the 
loans  made,  range  from  25  to  30  per  cent  of  the  market  value 
of  the  outstanding  timber.  This  should  vary  with  the  charac- 
ter of  the  wood,  size  of  the  logs,  quantity  of  timber  per  acre, 
cost  of  the  output,  and  accessibility  to  the  market. 

Thirdly,  the  provisions  for  the  cutting  of  the  timber  are  pecu- 
liar only  to  the  timber  bond.  One  provision  in  the  mortgage 
deed  uniformly  provides  that  the  timber  which  secures  this 
mortgage  cannot  be  cut.  This  provision  would  defeat  the  pur- 
pose of  the  bond  issue,  as  no  logging  could  be  done;  but  the 
trust  deed  further  provides  that  the  trustee  may  release  a  cer- 
tain acreage  of  timber — for  illustration,  50  acres — from  the 


TIMBER  BONDS  475 

mortgage  for  cutting,  if  the  value  of  the  released  amount  is 
paid  for  in  cash  at  the  time  of  its  release.  The  amount  paid  the 
trustee  is  put  into  a  sinking  fund  which  is  used  in  paying  off 
the  principal  of  the  outstanding  bonds.  For  example,  if  a  loan 
of  $1.00  per  thousand  feet  has  been  made  and  the  cruiser's  re- 
port shows  that  the  first  area  selected  for  cutting  contained 
500,000  feet,  and  the  timber  is  valued  at  $4.00  per  thousand 
feet,  $2,000  would  be  paid  to  the  trustee.  This  process  is 
repeated  with  each  50-acre  tract  of  the  acreage  which  is  re- 
leased by  the  trustee.  Thus  the  bonds  are  retired  twice  as  fast 
as  the  timber  is  cut,  so  that  when  the  timber  land  is  half  cut, 
the  sinking  fund  should  have  been  paid  a  sufficient  amount  to 
retire  all  of  the  bonds.  The  trustee,  however,  does  not  release 
the  mortgages  on  the  land  itself,  but  only  on  the  timber.  The 
mortgage  on  the  land  continues  until  the  whole  debt  against  the 
properties  has  been  paid. 

The  majority  of  these  bonds  are  now  issued  for  ten-year 
periods  and  retired  by  a  sinking  fund  or  serial  payment  method. 
Thus,  as  the  trustee  meets  the  interest  charges,  he  also  retires  a 
portion  of  the  principal  as  each  serial  payment  falls  due,  thus 
increasing  the  security  of  the  bonds  still  outstanding.  A  recent 
tendency  is  to  make  the  first  payments  of  these  bonds  from  two 
to  three  years  after  the  date  of  issuance  in  order  to  assist  the 
corporation  through  the  development  stage.  This  period  should 
not  be  less  than  five  years.  A  number  of  companies  have  met 
with  embarrassment  because  they  were  required  to  make  these 
payments  too  soon.  The  trust  deeds  usually  further  provide 
that  the  corporation  may  call  the  bonds  in  part  or  in  whole  on 
any  interest  date  at  a  stipulated  premium  price  plus  the  accrued 
interest,  and  a  number  of  the  successful  companies  have  been 
able  to  take  advantage  of  this  provision. 

Timber  bonds  are  frequently  endorsed  by  private  indi- 
viduals. The  long  experience  and  ability  in  the  timber  business 
and  the  large  personal  fortunes  of  the  men  controlling  the 
industry  become  a  good  guarantee  for  the  security  of  these 
bonds.  Occasionally,  the  land,  instead  of  being  owned  in  fee, 
is  held  under  lease  with  the  right  to  cut  the  timber.  But  as  a 
rule  timber  lands  are  held  in  fee.  Bond  houses  are  reluctant 


476  INVESTMENT  ANALYSIS 

to  lend  large  amounts  on  leased  properties  because  of  the  in- 
creased possibilities  of  complications. 

In  concluding  the  discussion  on  legal  requisites,  a  statement 
should  be  made  as  to  the  possible  effect  which  serial  payments, 
under  certain  contracts,  might  have  on  the  safety  of  the  pay- 
ment of  the  interest  charges  and  principal.  When  the  serial 
payment  must  be  met  without  qualification,  it  becomes  neces- 
sary to  continue  cutting  timber  in  order  to  meet  the  maturing 
obligations,  though  these  payments  might  more  profitably  be 
postponed.  If  the  price  of  lumber  temporarily  falls,  the  mar- 
gin of  security  is  wiped  out  by  this  forced  sale  process.  And 
if  the  market  is  also  glutted,  it  may  result  in  the  corporation 
being  unable  to  meet  its  obligations.  This  is  the  embarrassment 
that  a  few  companies  experienced  just  prior  to  the  War.  Where 
the  market  can  absorb  the  output,  especially  if  prices  are  ad- 
vancing, this  difficulty  cannot  arise.  Though  the  prices  of 
forest  products  are  much  higher  than  they  were  twenty  years 
ago,  it  must  not  be  forgotten  that  acreages  are  also  often  pur- 
chased at  the  increased  prices,  and  consequently  these  corpora- 
tions have  much  narrower  margins  in  their  own  equity. 

Fire  Risks. — The  claim  made  by  bond  houses  dealing  in  tim- 
ber securities  that  no  serious  fires  now  occur  in  commercial  tim- 
ber cannot  be  accepted  in  its  entirety.  While  the  records  of 
certain  timber  bond  houses  do  show  an  absence  of  fire  losses  in 
the  last  fifteen  years,  the  testimony  of  forestry  experts  does  not 
altogether  agree  with  this  evidence.  It  is  true  that  the  reports 
of  the  latter  include  not  only  mercantile  timber,  but  also  forest 
reserves.  With  the  improved  ranger  organizations  of  the  United 
States  and  a  few  large  lumber  interests,  the  losses  in  the  ter- 
ritory covered  by  this  service  are  largely  confined  to  young 
.growth  and  small  areas  in  matured  forests.  It  is  probable  that 
in  75  per  cent  of  the  private  forests,  there  is  no  attempt  at  fire 
protection.1  The  majority  of  the  newspaper  reports  of  forest 
fires  are  greatly  exaggerated ;  nevertheless,  at  frequent  intervals 
large  losses  have  occurred.  While  the  largest  fire  losses  take 
place  in  young  growth  and  do  not  affect  the  mercantile  timber 


*H.  S.  Graves,  The  Principles  of  Handling  Woodlands,  p.  226. 


TIMBER  BONDS  477 

supply,  they  do  affect  the  future  supply.  According  to  M. 
E.  Griffith,  State  Forester  (1908)  of  Wisconsin,  the  damage  to 
mature  timber  in  that  state  in  1918  amounted  to  $9,000,000.*  In 
the  Bitter  Root  Reserve,  20  per  cent  of  the  yellow  pine  has 
been  destroyed  in  the  last  twenty  years,  and  in  the  Priest  Re- 
serve, 20  per  cent  of  the  timber  has  been  burned  out  in  a  period 
of  thirty  years.  The  United  States  Geological  Report  further 
states  that  out  of  a  particular  area  of  1,000  acres  in  the  Priest 
Reserve,  70  per  cent  of  the  standing  timber  has  been  destroyed 
by  fire.  Dr.  C.  A.  Schenck  estimates  that  approximately  2  per 
cent  of  the  woodlands  are  damaged  every  year  by  fire.2  An- 
other proof  that  the  risks  have  been  large  is  the  unwillingness 
on  the  part  of  insurance  companies  to  assume  the  risk.3  Ger- 
many, France  and  Austria,  with  their  more  highly  organized 
systems  of  forest  protection,  possess  rates  of  insurance  within 
the  range  of  possibility. 

The  fire  risks  vary  according  to  a  number  of  local  condi- 
tions. The  pine  belt  of  the  Southern  Appalachians  has  suffered 
little,  for  the  branches  are  extremely  high,  and  the  trees  widely 
separated.  "Where  small  underbrush  does  exist  and  is  burned,  it 
lessens  the  cost  of  logging.  The  swamps  of  Florida  and  Louisi- 
ana, and  parts  of  Northern  California,  Oregon,  Washington, 
and  Northwest  Canada,  rarely  experience  fires  because  of  the 
presence  of  fog  and  heavy  rainfalls.  Certain  species,  such  as 
the  Sequoias  (including  redwoods)  are  practically  immune  be- 
cause of  their  thick  bark.  Trees  with  heavy  sappy  leaves  also 
have  far  greater  resistance  to  fire  than  the  coniferous  trees  with 
resinous  foliage.  Droughts  and  dry  soils  also  increase  the  fire 
risks  of  certain  varieties  of  timber. 

It  is  often  possible  to  save  a  large  part  of  the  green  timber 
area  that  has  been  burned  over,  if  it  is  cut  within  two  years. 
This  is  especially  true  of  thick  barked  and  sappy  leaved  trees. 
"In  Oregon  there  is  a  company  engaged  in  logging  and  manu- 

^Wisconsin  State  Forestry  Report,  1908.  (Quoted  in  Taxation  of 
Forest  Lands  by  Alfred  K.  Chittenden  and  Harry  Jeion,  p.  50.) 

*Carl  A.  Schenck,  Some  Business  Problems  of  American  Forestry 
(1910),  p.  20. 

"Some  London  companies  have  underwritten  risks  in  South  America, 
but  the  rates  are  almost  prohibitive. 


478  INVESTMENT  ANALYSIS 

facturing  from  a  tract  of  red  cedar  that  was  killed  over  fifty 
years  ago.  It  is  in  an  excellent  state  of  preservation  today. ' '  * 
Other  varieties  of  trees  may  be  left  for  several  years,  if  they 
have  only  been  killed  but  not  seriously  burned.  Suffice  it  to 
say  in  conclusion,  that  as  far  as  fire  risks  offset  their  security, 
the  character  of  the  trees  and  locality  of  the  timber  area  are  of 
the  utmost  importance  to  the  investor  in  timber  bonds. 

The  Timber  Cruiser's  Valuation. — The  old  timber  cruisers 
were  termed  "land  lookers."  They  would  return  after  an  ex- 
amination of  a  forest  and  verbally  report  that  so  many  million 
feet  of  lumber  were  located  along  a  certain  stream  or  in  a  cer- 
tain township.  Gradually,  however,  with  the  demand  for  com- 
plete and  perfect  land  titles,  increased  competition,  and  increase 
in  the  value  of  standing  timber,  more  accurate  reports  were 
demanded.  Now,  with  the  actual  count  of  standing  timber 
required  by  the  conservative  timber  bond  underwriter, 
estimations  are  very  accurately  made,  not  only  of  the  total 
standing  timber,  but  also  of  the  various  kinds  of  wood  in  the 
area. 

There  is,  of  course,  a  great  deal  of  difference  in  the  accuracy 
with  which  the  estimations  are  made.  Cruisers  in  the  past 
have  not  infrequently  made  dishonest  returns.  In  fact,  in- 
stances have  been  known  where  the  cruiser  has  reported  two  to 
three  times  the  actual  amount  of  standing  timber.  Or  the  com- 
pany employing  the  cruiser  is  unwilling  to  pay  him  an  adequate 
sum  for  the  cruise,  and  his  estimate  consequently  is  made  in  a 
very  haphazard  manner,  simply  by  riding  through  the  tract. 
Often  a  bond  circular  will  state  that  various  tracts  of  the  acre- 
age have  been  checked,  and  the  estimate  made  on  the  basis  of 
this  check.  Now  it  is  quite  probable  that  the  cruiser  may  have 
selected  the  areas  of  heaviest  growth  to  make  up  his  check  list, 
and  the  actual  standing  timber  of  the  area  is  one-half  to  one- 
third  of  the  estimate  given  in  the  cruiser's  report.  No  cruise 
should  be  accepted  unless  it  has  been  made  on  a  zig-zag  count 


1H.  S.  Graves.  The  Principles  of  Handling  Woodlands.  (Our  losses 
from  diseases,  blights  and  insects  are  also  considerable  in  some  areas. 
In  the  last  decade  timber  has  been  damaged  by  beetles  to  the  amount 
of  $2,500,000  in  the  Black  Hills  of  South  Dakota  and  Wyoming.) 


TIMBER  BONDS  479 

over  half  the  area  of  every  forty  acres  of  the  acreage,  upon 
which  the  bonds  are  placed. 

Of  each  forty  acres,  the  cruiser's  report  should  state  in 
detail  the  amount  of  each  species,  quality  and  specific  gravity 
of  logs;  also  the  amount  of  timber  that  can  be  used  for  large 
and  small  poles,  ties,  and  posts,  and  the  cord  wood  or  wood  pulp 
that  might  be  obtained  from  the  tops.  The  quantity  of  bark 
that  could  be  used  for  tanning,  if  there  are  hemlock  trees,  and 
the  number  of  reproductive  tree-areas  should  also  be  given. 
Full  particulars  of  available  water,  ice,  snow,  railroad  or  public 
road  transportation,  distance  to  market,  climatic  conditions 
affecting  logging,  topography,  surface  indications  of  minerals, 
and  the  land  that  could  be  used  for  agricultural  purposes  are 
likewise  essential  to  a  complete  report. 

Balance  Sheet  and  Income  Statement. — One  of  the  most 
common  criticisms  that  can  be  made  of  timber  securities  is  the 
dearth  of  information  concerning  the  financial  status  of  the 
company  after  the  securities  have  been  floated.  In  1915  an 
inquiry  was  made  of  a  bond  house  concerning  a  company  whose 
bonds  they  had  underwritten  three  years  previous.  They  had 
no  information  of  any  kind  whatsoever  of  the  company.  The 
claim  made,  was  that  the  protection  given  the  bondholder 
through  the  sworn  statements  of  the  corporation  made  to  the 
trustees,  was  sufficient.  The  company  might  as  well  have  said 
that  so  long  as  the  interest  charges  were  paid  the  condition 
of  the  property  was  of  no  concern.  Needless  to  say,  this  invest- 
ment house  was  not  keeping  faith  with  its  clientele. 

It  is  as  imperative  to  the  sound  security  of  a  timber  com- 
pany, as  to  that  of  any  industrial,  that  its  financial  status  be 
known  as  that  the  rigid  requirements  of  its  trust  deeds  be  ful- 
filled. If  the  published  statements  of  timber  companies  were 
audited  by  a  reputable  accounting  firm,  they  would  serve  as  fur- 
ther evidence  of  the  truth  of  the  cruisers'  reports,  for  the  cer- 
tified accountant's  obligation  will  necessitate  his  passing  upon 
this  valuation.  The  condition,  variation  or  increase  in  accounts 
receivable,  accounts  payable,  inventories,  the  handling  of  depre- 
ciation, the  setting  up  of  the  proper  reserves,  the  proper  allot- 


480  INVESTMENT  ANALYSIS 

ment  of  costs,  and  the  continued  earnings  maintained  are  all 
factors  which  the  investor  is  entitled  to  know. 

The  Market. — The  comparative  newness  of  these  securities 
and  the  relatively  small  amount  yet  issued  greatly  limit  the 
breadth  of  their  market.  They  cannot  be  said  to  have  an  active 
market;  consequently  they  lack  ready  convertibility.  The  only 
possible  market  that  the  holder  of  a  timber  bond  has,  is  the 
issuing  investment  house,  and  in  rare  instances  some  lumber 
owners.  This  permits  the  issuing  bond  house,  where  it  pos- 
sesses the  funds  to  sustain  the  market  of  its  own  issue.  Where 
the  issuing  house  is  not  able  to  do  so,  in  case  of  a  depressed 
market  or  where  a  corporation  is  suffering  from  a  relapse,  there 
will  be  a  considerable  fall  in  the  price  of  the  security.  The 
possible  losses  under  such  a  condition  should  be  estimated  and 
an  equivalent  decrease  in  the  purchase  price  of  the  security  be 
required. 


BOOK  III 

BONDS  SECURED  BY  LAND 
OR  REAL  ESTATE 


CHAPTER  XXVIII 
REAL  ESTATE  MORTGAGES 

Mortgages  on  real  estate1  in  large  cities  are  becoming  more 
and  more  a  favorite  form  of  investment.  This  may  be  accounted 
for  by  the  rapid  growth  of  metropolitan  land  values  as  well  as 
the  high  yield  of  the  securities.  By  reason  of  age  and  basis  of 
security,  this  class  of  investments  should  long  since  have  held 
first  place  among  investment  offerings.  But  real  estate  mort- 
gages have  a  singularly  disorganized  market,  largely  owing  to 
the  difficulty  of  issuing  securities  of  standard  denominations 
such  as  are  possible  to  railroad  corporation  bonds.  This  has 
narrowed  the  market  for  these  securities  and  resulted,  as  a  rule, 
in  a  higher  yield  than  can  be  realized  from  other  securities  pos- 
sessing equal  safety. 

A  number  of  other  factors  have  also  contributed  to  both  the 
high  cost  and  unequal  rates  of  real  estate  mortgages.  The 
United  States,  until  very  recently,  has  been  continually  pioneer- 
ing and  developing  new  commercial  and  industrial  centers. 
Little  available  free  capital  exists  in  new  localities  for  invest- 
ment purposes,  as  surplus  funds  are  usually  reinvested  in  per- 
sonal enterprises.  In  the  early  days  of  the  investment  market, 
conservative  investors  in  the  Eastern  seaboard  states  who  were 
receiving  large  returns  on  railroad  securities  were,  with  few 
exceptions,  unwilling  to  risk  their  money  in  unknown  and  un- 
tried localities.  As  a  result,  when  funds  were  needed  for 
investment  in  mortgages,  it  was  necessary  to  obtain  them  from 
the  immediate  locality,  where  a  knowledge  of  the  security  was 
easily  obtained,  for  the  comparatively  large  cost  of  floating  a 


1PThoush  Real  Estate  and  Buildinsr  Lor.n  Associations  have  a  legiti- 
mate place  in  the  field  of  investments,  they  are  usually  not  included 
under  the  general  head  of  investment  securities. 

483 


484  INVESTMENT  ANALYSIS 

small  loan  in  a  wide  market  made  such  a  course  impractical. 
The  difficulty  of  securing  the  exact  sum  needed,  the  hesitancy 
to  make  long  time  inconvertible  loans,  and  the  difficulty  ex- 
perienced by  the  borrowers  in  securing  new  loans  with  which  to 
repay  their  obligations,  have  also  contributed  to  the  large  com- 
missions and  high  rate  of  interest. 

In  the  older  and  established  communities,  the  lack  of  a 
standard  market,  the  limited  number  of  property  units  large 
enough  to  allow  of  the  first  mortgage  being  split  into  units  of 
standard  denominations,  and  the  great  variation  in  the  charac- 
ter of  property  securing  mortgages  were  and  are  still  handicaps 
to  many  real  estate  mortgages.  With  certain  properties  these 
disadvantages  have  been  largely  overcome  by  corporations 
organized  for  the  purpose  of  issuing  bonds,  and  these  will  be 
discussed  in  greater  detail  in  a  following  chapter.  In  fairness, 
it  should  be  stated  that  there  are  a  few  of  the  largest  cities 
where  mortgage  rates  and  the  rates  upon  other  securities  pos- 
sessing the  same  safety  do  not  differ  very  much.  However, 
even  on  the  conservative  mortgage  during  the  last  fifteen  years 
the  general  average  interest  rates  have  increased  as  on  all  higher 
grade  securities.1  Exceptions  to  this  may  occur  where  a  small 
village  or  town  has  grown  into  a  city  of  considerable  size  and 
rates  have  been  lowered  because  of  increased  security.  Com- 
parison of  the  yield  upon  real  estate  mortgages  referred  to  here, 
of  course,  is  only  made  with  other  securities  possessing  equal 
safety;  otherwise  the  comparison  will  not  hold. 

The  large  variations  in  local  conditions  existing  within  even 
one  city  has  always  made  it  difficult  to  formulate  what  might 
be  called  the  general  principles  underlying  real  estate  mort- 
gages. This,  no  doubt,  accounts  for  much  of  the  desultory 
writing  upon  this  subject.  But  the  growing  importance  of 
these  securities  to  both  small  and  large  investors  makes  it  almost 
incumbent  that  a  discussion  of  them  be  given. 


*See  chapters  on  Market  Influences  on  Security  Prices,  chaps,  x  and 
xi. 

The  abnormal  condition  existing  in  the  market  at  the  present  writ- 
ing must  not  be  taken  as  a  criterion  for  a  permanent  real  estate  mort- 
gage market. 


HEAL  ESTATE  MORTGAGES        485 

Appraising  of  Real  Estate  Values.1 — The  attempt  to  lay 
down  any  rules  for  the  appraising  of  real  estate  values  is  prob- 
ably the  most  difficult  part  of  the  whole  analysis  of  real  estate 
mortgages.  The  frequency  with  which  variations  from  general 
rules  occur,  because  of  local  conditions  is  so  puzzling  to  any  one 
but  the  expert  real  estate  man,  that  the  layman  is  apt  to  draw 
the  conclusion  that  no  rules  for  the  valuation  of  real  estate 
exist.  Errors  in  judgment  due  to  these  variations  are  apt  to 
be  greater  in  the  valuation  of  real  estate  than  in  any  form  of 
corporation  valuation  and  also  will  have  a  more  far-reaching 
effect.  At  best,  the  problem  is  perplexing,  but  a  great  deal  of 
confusion  will  be  avoided  in  a  study  of  real  estate  values  if  the 
tendency  to  variation  which  is  implied  here,  will  be  borne  in 
mind  in  reading  these  pages. 

The  important  questions  that  should  be  answered  for  the 
investor  in  an  appraisement,  are:  what  possibility  is  there  of 
appreciation  in  land  values  and  what  effect  would  such  appre- 
ciation have  on  the  value  of  the  building?  What  is  the  rela- 
tion of  the  site  value  to  the  character  and  value  of  the  build- 
ing? "What  effect  does  the  present  rate  of  depreciation  have 
on  the  building?  What  are  the  costs  of  operating  the  building? 

Appreciation  of  Land. — The  purchase  of  short-term  mort- 
gages on  the  basis  of  land  value  is  usually  not  justified.  With 
a  long-term  mortgage,  appreciation  of  the  land  value  has  a 
perceptible  effect  on  the  market  price,  provided  a  purchaser  can 
be  found.  To  receive  the  immediate  benefit  of  this  appreciation, 
however,  the  income  from  the  building  upon  the  land  must  have 
increased  sufficiently  to  capitalize  the  land  at  that  price.  Where 
it  is  necessary  to  hold  a  mortgage  any  considerable  length  of 


*The  reader  will  find  R.  M.  Kurd,  Principles  of  City  Land  Values, 
and  A.  P.  Bolton,  Building  for  Profit,  useful  texts  to  read.  The  author 
has  drawn  the  larger  part  of  his  deductions  from  interviews  with  a  num- 
ber of  real  estate  firms  in  Chicago  and  New  York.  For  the  appraisement 
of  land  values  such  authorities  as  the  following  will  also  be  found  quite 
valuable:  William  E.  Davies,  Rules  in  the  Annual  Manual  and  Diary  of 
the  Real  Estate  Board  of  Neic  York;  Somers'  Si/stem  (pamphlet  by 
Manufacturers'  Appraisal  Company  of  Cleveland,  O.)  ;  see  also  discus- 
sions on  the  Hoffman  rule,  the  Heil  rule,  and  George  J.  Graiger  rule, 
etc.  See  also  the  Annual  Report  of  the  Commissioner  of  Taxes  and 
Assessments  of  New  York  City  for  1914. 


486  INVESTMENT  ANALYSIS 

time  before  appreciation  takes  place,  the  increased  returns 
resulting  therefrom  may  be  offset  by  the  loss  suffered  in  the 
return  on  the  investment  through  interest  charges,  taxes,  etc., 
during  the  period  preceding  this  increase  in  value.  Mr.  R.  P. 
Bolton  has  charted  a  series  of  figures  (on  a  plot  of  ground  in 
the  Bronx,  New  York  City)  gathered  by  Mr.  J.  C.  Davis  illus- 
trating this  fact.  The  principle  which  it  illustrates  should  be 
applied  where  anticipated  values  in  land  are  considered  as  a 
part  of  a  security.  Mr.  Davis'  conclusions  show  that  had  the 
owner  sold  the  plot  one  year  after  it  was  purchased,  the  trans- 
action would  have  yielded  25  per  cent  profit.  But,  as  a  result 
of  the  check  due  to  the  panic  in  1893,  the  taxes  and  interest 
charges  (during  the  next  eight  years)  offset  any  increase  in 
profit.  The  highest  point  in  value  was  reached  in  the  four- 
teenth year.  Had  the  owner  continued  to  hold  this  plot  at  this 
price  without  improvements  after  the  tenth  year,  all  profits 
would  have  been  consumed  in  interest  and  taxes.1 

In  property  securing  long  term  mortgages,  the  appreciation 
of  land  should  not  be  permitted  to  offset  the  depreciation  of 
buildings.  If  the  property  itself  is  held  as  an  investment,  this 
may  at  times  be  permissible,  though  most  frequently  it  is  unde- 
sirable. The  fact  is  often  overlooked  that  the  depreciation  of  a 
building  begins  immediately  after  its  construction.  Further, 
land  values  are  fluctuating  and  make  an  uncertain  basis  upon 
which  to  measure  depreciation,  if  a  sale  of  the  property  were 
required  before  the  replacement  of  the  building.  Ultimately, 
the  income  from  the  building  must  adjust  itself,  if  it  has  not 
already  done  so,  to  the  average  income  of  neighboring  build- 
ings. If  no  depreciation  fund  is  maintained  for  the  building, 
•the  rate  of  appreciation  must  be  extremely  large  to  offset  its 
depreciation  where  the  cost  of  the  building  very  greatly  exceeds 
that  of  the  land. 

The  rule  that  limits  a  building  to  such  height  as  will  permit 
its  rental  to  yield  a  legitimate  interest  on  land  investment, 
plus  the  cost  of  building,  has  in  the  past  been  violated  in  the 
erection  of  some  of  the  tower  buildings  in  New  York  City.1  The 


JR.  P.  Bolton,  Building  for  Profit,  pp.  16-18   (Mr.  Clarence  Davis' 
figures  were  published  in  1909). 


REAL  ESTATE  MORTGAGES        487 

ordinances  limiting  the  height  of  buildings  will  somewhat  lessen 
the  erection  of  disproportionately  high  buildings  in  central 
business  localities.1  The  erection  of  buildings  of  extraordinary 
height,  which  might  result  in  the  lowering  of  values  of  adjoin- 
ing properties,  as  was  the  case  with  the  Equitable  Life  Insur- 
ance building  of  New  York  City,  is  not  likely.  It  was  esti- 
mated that  the  property  on  Pine  Street  adjoining  the  EquitaWc 
Building  was  reduced  30  per  cent  in  value  at  the  time  of  the 
completion  of  this  building.2  There  is  a  tendency  in  the  large 
cities  for  certain  streets  to  be  monopolized  by  particular  trades. 
A  building  not  suited  to  the  purposes  of  the  trade  predominant 
in  one  of  these  localities  is  apt  to  prove  a  great  burden.  Resi- 
dences and  office  buildings,  next  to  retail  dealers'  establishments, 
are  more  susceptible  to  environmental  influences  than  whole- 
sale, loft  and  factory  buildings,  although  certain  types  of  the 
latter  group  will  be  radically  affected  by  the  movements  of 
railway  terminals.  A  large  modern  and  well-equipped  office 
building  in  lower  Manhattan  for  a  number  of  years  had  diffi- 
culty in  meeting  the  interest  on  its  bonds  because  the  building 
was  situated  out  of  the  office  building  area.  The  type  of 
building  best  adapted  to  a  site  depends,  therefore,  on  the 
character  of  the  neighboring  buildings,  the  character  of  the 
industry  in  the  locality,  and  the  internal  movement  of  popu- 
lation within  the  city.  The  rent  from  the  average  building 
in  a  locality  will  usually  determine  for  a  builder  the  amount 
he  is  warranted  in  putting  into  a  building  and  what  the 
operating  cost  of  the  structure  will  be. 

The  Effect  of  Structure  Values. — The  erection  of  high 
buildings  does  not  always  increase  land  values.  This  was  true 
of  lower  Wall  Street  and  Broadway,  New  York,  for  a  number 
of  years.  The  stability  of  location,  in  the  long  run,  can  be 
maintained  only  by  a  correct  ratio  between  land  and  buildings. 
That  is,  the  value  of  the  land  should  be  somewhat  near  the 
capitalization  of  the  net  rent  from  the  building.  "Warranted 
exceptions  to  this  rule  are  found  in  a  few  such  districts  as  Lower 


'R.  M.  Hurd  in  his  Principles  of  City  Land  Values  (pp.  97-121)  gives 
a  number  of  cases  of  the  lack  of  the  adaptation  of  buildings  to  land. 
'Franklin  Fishier,  Moody  Magz.,  vol.  xiv  (Dec.,  1912),  p.  427. 


488  INVESTMENT  ANALYSIS 

Manhattan  and  the  Loop  district  of  Chicago,  but  normally  it 
is  a  standard  that  should  rarely  be  departed  from.  If  the  line 
of  traffic  is  changing  rapidly,  or  the  system  of  taxation  per- 
mits, cheap  buildings  may  be  erected  on  high-priced  land.  But 
in  the  majority  of  cases  it  is  questionable  whether  the  invest- 
ment is  returning  all  it  can  if  the  land  and  building  values  are 
not  in  correct  proportion. 

Mortgages  have  been  issued  in  the  past  on  poorly  located 
office  buildings  in  both  Chicago  and  New  York,  whose  return 
on  the  total  investment  netted  less  than  4  per  cent.  Now,  if  the 
margin  of  these  loans  had  been  larger,  the  strength  of  the  mort- 
gage's earning  power  would  have  been  more  than  relatively 
strengthened,  and  the  margin  of  safety  to  the  bondholder  would 
likewise  have  been  materially  increased.  On  the  other  hand, 
an  unusual  location  may  at  times  be  acceptable,  though  any 
considerable  variation  from  the  standard  of  the  locality  must 
be  well  scrutinized  to  be  certain  of  its  justification.  Most  fre- 
quently such  variation  indicates  a  lack  of  proper  structural 
value,  and  in  the  long  run,  results  in  a  proportionate  decrease 
in  the  return  on  the  total  investment.  "With  buildings  of 
cheaper  construction,  such  as  can  be  used  for  warehouses,  where 
it  is  not  necessary  that  they  be  located  in  particular  localities, 
considerable  increase  in  their  land  values  is  to  be  expected  in 
growing  cities.  A  much  larger  temporary  rate  of  return  must 
consequently  be  demanded  on  these  properties. 

Houses,  tenements,  and  apartments  show  much  wider  varia- 
tions than  any  of  the  commercial  buildings.  Where  residential 
buildings  are  erected  in  densely  populated  localities  and  land 
is  approaching  the  maximum  point  of  appreciation,  the  cost 
of  the  buildings  should  never  very  greatly  exceed  the  land 
value.  Prior  to  the  European  war  and  especially  a  decade 
ago,  apartments  forced  into  existence  generally  did  not  exceed, 
with  rare  exceptions,  from  four  to  five  times  the  value  of 
the  land.  "  Under  the  present  rather  abnormal  conditions, 
where  the  cost  of  building  has  advanced  very  rapidly  while 
the  cost  of  land  has  remained  nearly  stationary,  the  former 
generally  held  ratio  of  five  to  one  is  no  longer  adhered  to, 
and  apartment  houses  now  quite  normally  cost  about  ten  times 


REAL  ESTATE  MORTGAGES        489 

the  land  value.  This  condition,  however,  may  not  continue."1 
When  in  anticipation  of  increased  population,  apartments  have 
been  built  too  large  for  present  demand,  they  have  often 
proved  failures.  The  disadvantage  in  erecting  buildings  whose 
cost  is  too  great  in  comparison  with  the  value  of  the  land  is 
that  depreciation  of  the  buildings  takes  place  more  rapidly 
than  appreciation  in  the  land.  This  latter  statement,  of  course, 
again  applies  to  construction  under  normal  conditions. 

New  buildings  in  a  district  have  not  infrequently  largely 
determined  the  immediate  value  of  the  property  already  in  that 
locality.  This  brings  real  estate  into  the  field  of  pure 
speculation,  though  a  number  of  debenture  issues  have  fre- 
quently been  placed  on  properties  of  this  character  where  the 
building  was  done  on  a  large  scale.  However,  very  frequently, 
the  anticipation  is  discounted  for  too  short  a  period,  and  prices 
drop  after  the  first  development  takes  place.  To  force  subur- 
ban land  on  the  market  before  there  is  a  real  demand  for  it  is  a 
shortsighted  policy,  for  it  brings  the  cheapest  tenants  and 
destroys  a  possible  later  development  of  more  profitable  build- 
ing. Again,  the  higher  the  rents  the  more  susceptible  is  the 
investment  to  its  environment.  The  best  locality  for  a  building 
is  one  in  which  buildings  like  itself  predominate,  though  a  lim- 
ited number  of  cheap  houses  can  be  built  in  a  good  neighbor- 
hood and  demand  a  good  return.* 

In  small  towns,  land  values  vary  so  much  that  it  is  impos- 
sible to  lay  down  any  but  the  most  general  rules  as  to  what 
should  be  the  value  of  the  building  in  proportion  to  that  of  the 
land.  While  the  principle  remains  the  same,  the  ratio  in  which 
it  holds  true  must  vary  with  every  locality.  It  might  be  safe 
to  lay  down  a  fixed  rule  that  in  a  certain  part  of  a  town  the 
cost  of  houses  should  not  exceed  three  times  that  of  the  land 
value,  whereas  in  another  part  of  the  same  town,  it  might  be 
necessary  to  make  it  five.  The  latter  ratio  refers  to  cottages 
built  in  large  groups  for  investment  purposes.  Large  resi- 
dences, strictly  speaking,  in  small  towns  or  cities,  can  have  no 


'Quoted  from  letter  of  George  A.  Hurd,  August  4.  1920. 

2R.  M.  Hurd.  Principles  of  City  Land  Values  (1903),  chap.  viii. 


490  INVESTMENT  ANALYSIS 

established  place  in  the  mortgage  investment  field.  When 
foreclosure  or  vacating  of  the  property  takes  place,  the  risk  of 
a  continued  vacancy,  as  a  general  rule,  is  too  great  to  warrant 
the  purchase  of  these  mortgages  for  investment  purposes. 

Depreciation  of  Building. — The  importance  of  depreciation 
to  the  mortgage  holder  increases,  both  with  the  increased  ratio 
of  building  values  to  the  land  and  with  the  size  of  the  building. 
While  the  depreciation  of  new  buildings  should  be  taken  into 
consideration,  it  is  not  of  as  much  importance  relatively  to 
the  mortgage  bondholder  as  to  the  owner  of  the  real  estate.  The 
common  practice  is  always  to  extinguish  the  mortgage  long 
before  the  structural  value  of  the  building  is  "seriously  or  ma- 
terially" depreciated.  The  greatest  danger  does  not  lie  in  the 
physical  deterioration  of  the  building,  but  rather  in  either  the 
movement  from  the  locality  of  the  trade  or  industry  located 
there,  or  in  the  building  becoming  out  of  date.  The  greater 
danger  exists  in  the  latter  case,  many  owners  of  real  estate  hav- 
ing been  spared  great  losses  only  by  the  rapid  appreciation  of 
land  values.  This  has  been  particularly  true  of  office  buildings 
and  apartments. 

A  new  office  building  has  frequently  largely  emptied  old 
buildings  in  the  same  neighborhood,  especially  if  the  old 
buildings  have  specialized  in  tenants  of  one  trade  or  profession. 
Leases  on  the  old  buildings  will  be  taken  from  the  tenants  by 
real  estate  renting  agencies  in  order  to  secure  desirable  tenants 
for  the  new  building.  In  both  apartment  and  office  buildings, 
such  movements  result  in  a  considerable  reduction  of  the  rental 
value  of  the  buildings.  And  as  operating  costs  usually  consume 
a  large  portion  of  the  rentals  in  the  more  expensive  buildings 
of  this  type,  a  fall  in  gross  rentals  causes  a  greater  relative 
drop  in  net  income  as  the  expensiveness  of  the  building 
increases. 

In  appraising  an  old  building  upon  which  a  mortgage 
issue  is  to  be  placed,  the  degree  to  which  it  can  be  made  to 
fit  modern  demands  is  an  essential  consideration.  Such  build- 
ings are  frequently  allowed  to  stand  idle  so  long  that  (even 
where  land  values  have  increased)  the  property  ceases  to  give 


REAL  ESTATE  MORTGAGES        491 

a  legitimate  rate  of  interest.  As  far  as  structural  deprecia- 
tion is  concerned,  a  sufficient  margin  should  be  allowed  between 
the  original  value  and  the  present  depreciated  price  of  the 
building.  The  appreciation  of  land  also  often  more  than  off- 
sets the  depreciation  of  the  building.  If  the  building  is  old, 
but  its  environment  still  good,  the  conservative  policy  is  to  con- 
sider only  the  land  value  as  a  basis  for  the  loan.  But  if  its 
environment  has  likewise  deteriorated,  the  property  should  not 
be  considered  under  any  circumstances  by  the  investor,  as  it  is 
a  purely  speculative  purchase. 

Building  as  Related  to  Demand  of  Locality. — A  comparative 
study  of  the  structural  value  of  buildings  is  more  easily  made 
on  the  basis  of  the  cubical  contents  of  the  buildings  than  by  any 
other  method.  Though  this  method  of  securing  the  value  is  not 
always  absolutely  accurate,  because  of  the  variations  in  the 
details  of  the  buildings,  it  will  be  approximately  so  for  given 
localities.  After  a  given  height  or  expansion  in  the  area  cov- 
ered by  the  building  has  been  reached,  the  costs  of  construction 
will  increase  at  a  more  rapid  rate.  For  illustration,  the  cost  of 
office  buildings  will  increase  at  a  given  rate  of  cost  per  story 
up  to  ten  and  twelve  stories,  when  the  cost  will  be  retarded  up 
to  the  sixteenth  to  eighteenth  story,  and  very  rapidly  increase 
above  that  number. 

Cost  of  Operating  Property. — Operating  statistics  from 
reliable  sources  are  too  few  to  permit  of  the  drawing  of  any 
general  conclusions.  Data  from  a  number  of  individual  build- 
ings have  been  published,  but  there  are  not  enough  of  them  to 
enable  the  investor  to  know  whether  they  are  representative. 
Office  and  apartment  buildings,  upon  which  most  mortgages 
and  mortgage  bonds  are  placed,  have  not  always  been  planned 
with  the  greatest  efficiency  in  the  proportionment  of  their  ex- 
penditures. The  best  way  of  determining  the  importance  of 
these  variations  in  operating  costs,  is  to  find  the  ratio  of  the 
various  operating  items  separately  to  gross  and  net  profits  and 
to  the  value  of  the  total  investment,  and  from  these  proportions 
determine  wrhether  the  special  operating  charges  necessary  in 
rendering  these  special  services  are  burdensome. 

In  addition  to  the  tax  that  is  levied  on  the  mortgage-holders 


492  INVESTMENT  ANALYSTS 

in  most  states,  there  is  the  tax  which  is  levied  on  the  real  prop- 
erty. And  every  mortgage  deed  should  provide  for  the  guar- 
antee of  the  payment  of  its  tax,  together  with  ample  fire 
insurance  to  protect  the  principal  of  the  mortgage.  The  varia- 
tion found  in  this  tax  is  often  relatively  greater  than  that  found 
in  the  net  rate  of  income  from  the  building  itself.  The  unequal 
burden  of  taxation  placed  on  real  property  is  such  an  old  story 
that  it  scarcely  needs  to  be  more  than  suggested  here.  Valua- 
tion has  always  been  inclusive  of  land  and  buildings,  and  there- 
fore an  inequitable  tax  burden  has  been  placed  on  improve- 
ments. 

The  amounts  entering  into  fixed  charges,  maintenance,  and 
special  maintenance  of  equipment,  have  been  more  reliably 
tabulated  on  New  York  property  than  any  other  city  and  show  a 
very  wide  range.  So  wide  is  the  range  in  fixed  charges  in  fact, 
that  it  is  quite  safe  to  assume  that  this  range  would  include 
the  standard  of  measurement,  except  that  the  third  item  would 
be  slightly  less  proportionately  on  apartment  houses  in  cities 
outside  of  New  York.  The  items  of  special  equipments  and  ser- 
vice devices  need  to  be  watched  with  particular  care  in  certain 
types  of  office  buildings  and  modern  apartments.  "Where  power, 
heat,  and  light  equipment,  etc.,  are  furnished  in  a  building,  the 
charges  increase  in  a  larger  relative  proportion,  though  excep- 
tions in  certain  expenses  may  exist  because  of  certain  peculiar 
local  advantages.  For  example  in  Chicago,  where  the  Com- 
monwealth Edison  is  offering  such  cheap  rates  for  power  and 
light,  these  items  have  been  greatly  reduced  under  the  New 
York  figures,  but  Chicago  is  at  a  greater  advantage  than  most 
American  cities  in  this  regard.  In  other  cities,  however,  the 
operating  costs  do  not  approach  those  of  New  York  as  the  lower 
buildings  in  other  cities  do  not  require  the  larger  expenditures 
of  the  high  buildings  in  New  York. 

IN  PER  CENT  OF  GROSS  INCOME 

Special  Equipment 
Fixed  and  Special 

Charges         Maintenance     Services 

Warehouses,  lofts,  etc 15  to  25          5  to  10        10  to  15 

Office  buildings   10  to  20         10  to  18  8  to  25 

Apartments     8  to  18        18  to  30        10  to  30 


REAL  ESTATE  MORTGAGES        493 

Margin  of  Loan. — The  average  loan  on  real  estate  mortgages 
should  vary  both  with  the  size  of  the  city  and  the  district  within 
the  city.  In  cities  from  20,000  and  up,  conservative  loans  on 
the  average  central  business  property  of  the  city  for  a  long 
time  past  have  been  made  safely  for  50  per  cent  of  the  value 
of  the  property.  But  even  in  cities  over  400,000  the  general 
business  custom  is  not  to  exceed  a  loan  value  of  50  to  60  per 
cent  of  the  value  of  the  property  in  the  best  central  business 
district,  except  in  New  York  City,  and  there,  there  is  a  growing 
feeling  that  the  limit  for  Savings  Banks  loans  of  60  per  cent 
should  not  be  exceeded  in  any  mortgage  issue.  The  only  man- 
ner in  which  one  can  accurately  determine  what  this  margin 
should  be  is  to  study  the  fluctuation  of  values  in  the  locality 
over  a  series  of  years  to  determine  whether  the  proposed  loan 
is  in  danger  of  passing  beyond  the  margin  that  is  essential  for 
safety. 

Taxation  of  Mortgages. — The  majority  of  the  states  assess 
mortgages  as  personal  property,  and  the  courts  have  sustained 
the  principle  that  real  property  and  mortgages  are  distinct 
objects  of  taxation.  There  are,  however,  a  few  exceptions  to 
this  generally  accepted  ruling.  In  California,1  Colorado,  Con- 
necticut, Massachusetts,  New  Jersey,  and  Wisconsin,  the  mort- 
gage is  taxed  as  part  of  the  real  estate  and  the  mortgage  is  ex- 
empt. Idaho  and  Washington  exempt  all  mortgages  from  taxa- 
tion. Alabama,  Minnesota,  and  Virginia  allow  mortgages  to  be 
exempted  if  a  privilege  tax  is  paid  at  the  recording  of  the 
mortgage.  Indiana  allows  a  deduction  not  exceeding  $700. 
Pennsylvania  has  a  fixed  tax  of  four  mills  on  all  mortgages. 
Most  of  the  other  states  tax  mortgages  as  personal  property. 

While  the  law  of  taxing  mortgages  as  personal  property  still 
exists,  it  has  never  been  rigidly  enforced,  or  if  enforced,  the 
tax  has  been  shifted  by  a  contract  between  the  mortgager  and 
the  mortgagee  so  that  the  former  pays  the  tax.  If  the  statute 
prohibits  this  shift,  as  in  California  and  Oregon,  the  interest 


''California  and  Oregon  separate  the  two,  but  allow  the  mortgagor  to 
deduct  the  amount  of  the  mortgages.  ( Sav.  Soc.  vs.  Multomals,  169  U.  S. 
421.) 


494  INVESTMENT  ANALYSIS 

rate  has  been  increased.1  This  enforcement  of  a  specific  mort- 
gage tax  is  illustrated  in  the  New  York  law,  which  was  repealed 
on  the  conclusive  evidence  shown  by  Mr.  Lawson  Purdy  that 
interest  rates  were  increased  more  than  the  specific  tax  on  mort- 
gages.2 "The  general  rule  which  explains  the  shifting  of  a 
mortgage  tax  to  the  borrower,"  further  states  Professor  Selig- 
man,  "may  be  modified  by  such  considerations  as,  (1)  that  the 
tax  is  unusually  low,  or  (2)  that  the  normal  rate  of  interest  on 
mortgages  is  exceptionally  high,  or  (3)  that  the  demand  for 
capital  is  inordinately  keen,  or  (4)  that  the  stability  of  land 
values  is  not  sufficiently  assured  to  attract  an  influx  of  capital 
from  the  outside  and  thus  to  affect  the  supply. ' ' 

As  long  known,  taxation  on  both  real  estate  and  mortgages 
may  cause  serious  interference  with  the  improvement  of  city 
property.  If  rental  and  taxes  move  forward  at  the  same  rate 
or  taxes  move  at  a  faster  rate,  improvements  will  be  perma- 
nently checked.  But  this  is  a  problem  involving  the  landowner 
directly,  and  a  factor  only  indirectly  affecting  the  mortgage- 
holder  in  its  influence  on  all  land  values. 

Convertibility  and  Hypothecation. — Mortgages,  as  a  class, 
lack  the  convertibility  possessed  by  bonds.  The  impossibility 
of  standardization,  as  with  bonds,  already  referred  to,  will 
always  prevent  even  with  high-class  mortgages,  the  rapidity  of 
exchange  enjoyed  by  bonds  of  a  well-established  corporation. 
During  periods  of  severe  depression  the  value  of  properties, 
especially  those  used  for  particular  purposes  and  suburban 
property,  is  subject  to  extreme  relapses  in  value.  On  the  other 
hand,  in  recent  years  the  phenomenal  rise  in  values  has  saved 
many  hypothecators.  This  lack  of  fluidity  makes  mortgages 
correspondingly  less  desirable  to  the  banker  when  they  are  used 
for  purposes  of  hypothecation.  It  is  also  necessary  that  the 
banker  ascertain  for  himself  the  security  of  title  and  other 
safeguards  of  the  investment,  except  where  he  is  willing  to 
accept  the  issues  of  a  mortgage  banking  house. 

Denomination,  Maturity  and  Yield. — The  common  objections 


JR.  A.  Campbell,  Mortgage  Taxation  (Wis.  Pub.  Library,  p.  60). 
JLawson  Purely.  Mortfiaf/e  Taxation  and  Interest  Rates   (1906). 
*R.    A.    Seligman,    Shifting    and    Incidence    of    Taxation    (1910), 
pp.  834-335. 


EEAL  ESTATE  MORTGAGES        495 

made  by  bond  houses  to  the  purchases  of  mortgages  are  their 
denominations  and  maturities.  There  are  no  standardized  issues, 
and  every  time  a  borrower  enters  the  market,  an  investor  must 
be  found  who  is  willing  to  invest  the  specific  amount  of  the 
mortgage  offered.  As  the  mortgages  become  larger,  the  num- 
ber of  investors  decrease  at  an  increasingly  rapid  ratio,  as  in- 
vestors of  large  amounts  are  mindful  of  the  necessity  of  the  dis- 
tribution of  risks.  If  a  single  investor  cannot  be  found,  it  is 
necessary  for  the  mortgagor  to  split  his  mortgage  into  two  or 
more  mortgages,  and  this  involves  extra  cost.  "When  the  mort- 
gage has  reached  a  sufficient  amount,  such  as  on  apartment 
houses,  the  difficulty  is  simplified  as  in  a  railroad  mortgage  by 
issuing  bonds  against  the  mortgage  and  splitting  up  these  bonds 
into  desired  denominations.  But  this  takes  us  outside  of  the 
straight  mortgage  as  such. 

With  the  increase  of  local  capital,  the  difficulties  of  readily 
disposing  of  mortgages  at  all  times  are  becoming  more  and 
more  minimized.  A  number  of  local  banks  in  the  Middle  West 
and  Western  States,  where  surplus  funds  are  now  accumulat- 
ing, are  disposing  of  these  mortgages  of  larger  amounts  to 
several  participating  investors.  The  popular  demand  of  small 
investors  for  $500  investments  is  steadily  growing;  and  with 
this  increasing  market,  local  banks  of  small  towns  and  cities 
will  participate  more  actively  than  ever  in  the  business. 

The  duration  of  the  average  mortgage  is  even  more  objec- 
tionable than  the  denomination.  An  investor  is  desirous  of  plac- 
ing his  funds  into  more  or  less  permanent  form,  but  as  mort- 
gages mature  in  five  to  ten  years,  more  frequenly  five,  the 
investor  is  constantly  inconvenienced  in  looking  for  new  mort- 
gages for  the  specific  sum  he  has  to  invest.  And  unless  he  is 
able  to  investigate  titles,  etc.,  each  new  investment  involves  a 
considerable  expenditure  that  decreases  the  net  yield. 

Where  the  price  level  is  moving  steadily  upward,  the  short 
duration  has  the  advantage  over  the  long-term  security,  as 
the  interest  rates  in  a  locality  and  the  slowness  of  interest  rates 
in  adjusting  themselves  to  changing  price  levels,  often  prevent 
any  advantages  from  accruing  to  the  investor.  Where  there  is 
a  falling  of  the  price  level,  and  a  rapid  readjustment  of  rates, 
the  mortgage-holder  is  a  loser. 


CHAPTEE  XXIX 
EEAL  ESTATE  BONDS 

As  pointed  out  in  the  previous  chapter  the  difficulty  of 
securing  small  unit  investments,  which  tends  to  offset  the  advan- 
tages of  real  estate  mortgages  especially  to  the  small  individual 
investor,  has  been  overcome  by  the  formation  of  real  estate 
investment  corporations  and  real  estate  bond  underwriting 
firms.1  This  has  been  made  possible  by  the  large  increase  in 
the  value  of  urban  property  which  now  warrants  the  erection 
of  larger  single  structures  on  one  site.  These  structures  have 
become  both  so  numerous  and  so  large  that  the  individual 
capitalist  is  no  longer  able  to  finance  them.  And  thus  a  field 
has  been  created  for  the  real  estate  investment  company. 

The  common  practice  of  these  companies  has  been  to  build 
or  purchase  a  large  property  and  dispose  of  it  as  soon  as  a 
profitable  market  is  offered.  The  business  of  the  company  is 
financed  by  the  issuing  of  bonds.  Either  the  bond  issue  is 
placed  on  each  individual  property  or  the  bond  is  issued  on  the 
basis  of  a  single  mortgage.  The  company  retains  the  privilege 
of  withdrawing  a  certain  proportion  of  the  property  and  sub- 
stituting other  property  of  equal  value.  The  permanent  hold- 
ing of  property  by  these  companies  is  an  innovation,  but  one 
which  offers  great  possibilities  for  the  future.  A  decided  move 
in  this  direction  will  go  far  toward  the  separation  of  the  purely 
speculative  and  investment  real  estate. 

The  real  estate  bond  investment  houses  occupy  the  same 
position  toward  the  financing  of  real  estate  properties  as  do  the 
underwriters  of  any  other  corporate  securities.  They  either 
purchase  the  mortgages  outright  and  advance  the  money,  or 


*For  Legal  Savings,  Appraising  of  Real  Estate,  Title,  Increase  in 
Values  of  Mortgages,  Title  and  Taxation,  see  chapter  on  Real  Estate 
Mortgages. 

496 


IlEAL  ESTATE  BONDS  497 

they  assume  the  responsibility  of  selling  the  bonds  for  a  com- 
pany likewise  secured  by  a  mortgage  deposited  with  a  trustee. 
These  bonds  will  be  the  subject  of  discussion  in  this  chapter. 
As  the  principles  which  govern  the  valuation  of  the  real  estate 
mortgage  upon  which  the  bonds  are  placed  have  already  been 
analyzed  in  the  previous  chapter,  it  will  not  be  necessary  to 
repeat  the  discussion. 

Classification. — The  three  types  of  real  estate  mortgage 
bonds  commonly  used  are:  the  real  estate  mortgage  bond,  the 
debenture  bond,  and  the  leasehold  mortgage  bond.  The  certifi- 
cates of  partial  payment  and  guarantee  mortgage  bonds  are 
only  a  variation  of  one  of  these  three  types. 

Real  Estate  Mortgage  Bonds. — The  real  estate  mortgage 
bonds  are  secured  by  mortgages  or  trust  conveyances  of  real 
estate.  They  may  be  either  a  first  or  junior  lien,  and  are  se- 
cured by  a  definite  mortgage  or  mortgages  which  are  placed 
with  a  trustee.  These  bonds  are  then  usually  issued  in  series 
of  convenient  denominations  which  will  make  them  quickly  sale- 
able by  the  banker  underwriting  the  issue.  The  method  of  sell- 
ing and  the  general  issuance  problems  are  no  different  from 
those  found  in  other  forms  of  corporate  securities  underwritten 
by  an  investment  banker.  The  value  of  these  bonds  is  deter- 
mined by  exactly  the  same  methods  as  those  already  elaborated 
in  the  preceding  chapter. 

When  the  real  estate  mortgage  bonds  are  sold  against  a 
mortgage  which  a  real  estate  investment  company  has  the  right 
to  replace  with  other  mortgages,  these  bonds  are  quite  different 
from  the  type  referred  to  above.  Bonds  secured  by  mortgages  of 
this  character  are  frequently  called  collateral  trust  mortgage 
bonds,  though  this  name  is  frequently  incorrectly  applied  to 
bonds  of  the  former  type.  It  would  be  well  if  the  name  col- 
lateral trust  mortgage  bond  could  be  limited  to  bonds  of  the 
latter  type  so  that  they  could  be  correctly  distinguished  through 
their  nomenclature. 

The  privilege  allowed  the  investment  company  of  substitut- 
ing other  mortgages  for  the  mortgages  originally  securing  the 
bonds,  permits  it  to  take  advantage  of  a  desirable  profit  in  any 
particular  part  of  its  holdings  and  in  purchasing  other  parcels 


498  INVESTMENT  ANALYSIS 

of  real  estate.  This  may,  of  course,  prove  a  danger  if  the  com- 
pany's officials  are  inclined  to  speculate. 

The  safety  of  these  bonds  is  determined  not  only  by  the 
ratio  of  the  bonds  to  their  collateral  but  by  the  amount  of  the 
mortgages  to  the  value  of  the  property,  and  their  .rate  of  yield. 
It  can  be  generally  assumed  that  an  increasing  yield  is  an  indi- 
cation of  a  relatively  increasing  weakness  in  the  stability  of  the 
property  securing  the  loan.  While  this  narrowing  of  the  margin 
yields  a  larger  net  profit  to  the  investment  company  issuing  the 
bonds  on  the  mortgages,  it  generally  lessens  to  an  equal  degree 
the  value  of  the  security  to  the  investor.  A  guarantee  of  the 
principal  and  interest  then  is  highly  desirable,  but  this  will  be 
discussed  under  the  special  topic  of  guaranteed  bonds,  as  guar- 
antees are  also  applicable  to  the  other  classes  of  real  estate 
bonds. 

Debenture  Mortgage  Bonds. — These  bonds  possess  the  char- 
acteristics already  attributed  to  debentures,  usually  being  a 
general  lien  upon  the  assets  of  the  company.  These  assets 
include  both  property  and  mortgages  owned,  the  proportion  of 
each  varying  with  different  companies,  but  those  proportions 
are  not  so  important  to  the  investor  as  a  specific  knowledge  of 
the  character  of  the  assets  themselves. 

The  prospectuses  and  bond  circulars  of  many  of  these  com- 
panies leave  the  impression  that  these  bonds  are  first  claims 
upon  stipulated  assets.  These  prospectuses  do  not  reveal  all 
the  facts;  the  bonds  are  a  lien  upon  all  assets,  but  not  the  only 
lien.  A  very  heavy  mortgage  may  already  exist  on  the  property 
and  consequently  the  bond  security  may  be  almost  valueless.  If 
a  prior  mortgage  or  mortgages  are  outstanding  on  the  property 
owned,  there  should  be  a  sufficient  margin  to  safeguard  the  in- 
terests of  the  bondholder,  as  these  mortgages  are  prior  liens 
to  the  claims  of  the  bondholders.  If  the  amounts  of  the  mort- 
gages and  bonds  are  both  large,  the  interest  charges  are  an 
abnormal  burden,  so  that  it  will  require  a  very  large  income 
to  insure  absolute  safety  of  interest  payments.  Such  a  condi- 
tion of  liens,  with  few  exceptions,  must  be  considered  pre- 
carious by  the  investor  and  the  issue  be  wholly  disregarded. 

The  practice  of  a  number  of  these  companies  at  their  incep- 


REAL  ESTATE  BONDS  499 

tion  has  been  to  control  a  valuable  site,  which,  as  the  company 
has  grown,  the  officials  have  withdrawn,  substituting,  therefore, 
a  less  valuable  piece  of  property,  always  valued  by  the  com- 
pany's own  appraisers  at  the  same  price  as  the  original  prop- 
erty. Others  have  acquired  tracts  of  land  in  outlying  districts 
which  have  had  no  appreciable  growth  for  a  number  of  years,, 
and  in  which  the  promise  of  development  is  not  soon  likely  to  be 
fulfilled.  The  great  majority  of  American  cities  are  not  as  well 
established  as  the  European  cities  in  their  environs,  and  there 
is  always  the  possibility  that  the  direction  of  their  growth  will 
be  changed  or  one  of  the  outlying  areas  will  be  settled  long 
before  another  one  has  fairly  started  to  develop.  Speculative 
companies  of  this  character  usually  fail  under  the  first  strain  of 
the  market.  A  few  years  ago  a  communication  came  into  the 
author's  office  from  a  woman  who  had  been  left  a  sufficient 
amount  to  provide  her  with  a  modest  but  comfortable  income. 
The  letter  asked  whether  she  should  invest  the  total  amount 
in  the  debenture  bonds  of  a  certain  real  estate  company.  She 
further  desired  to  telegraph  an  immediate  acceptance  of  the 
purchase,  as  the  company  in  a  personal  letter  answering  her 
request  for  information  announced  that  the  amount  of  bonds 
left  to  be  sold  was  just  equal  to  her  total  capital.  This  com- 
pany, in  addition  to  the  6  per  cent  interest  on  its  bonds,  offered 
one-half  of  its  net  profits  to  the  bond  holders.  She  had  no 
further  evidence  concerning  the  company  than  the  falsified 
statements  contained  in  the  advertising  circular.  In  less  than 
a  year  the  company  failed.  These  companies  are  spoken  of  here 
because  so  many  people  have  unsuspectingly  been  led  into  buy- 
ing these  securities  thinking  that  they  were  purchasing  an  in- 
vestment. Fortunately  there  are  not  as  many  of  these  com- 
panies now  as  formerly,  and  because  of  more  stringent  laws,  it  is 
more  difficult  for  them  to  operate. 

On  the  other  hand,  some  of  the  very  strongest  and  oldest  of 
our  real  estate  companies  issue  debenture  bonds.  But  the  loca- 
tion and  stability  of  their  properties  and  the  ratio  of  funded 
liability  are  such  that  large  margins  secure  the  safety  of  prin- 
cipal and  interest  payments.  With  such  evidence  of  stability 
these  securities  can  well  be  classified  as  investments.  Further, 


500  INVESTMENT  ANALYSIS 

the  security  of  these  companies  is  such  that  they  are  never 
forced  in  a  strained  market  to  make  great  sacrifices  in  order  to 
meet  maturing  obligations  and  interest  payments.  Whether 
these  bonds  are  speculative  debenture  bonds,  or  investment 
debenture  bonds,  is  determined  by  which  of  the  above  policies  is 
pursued  by  the  company  issuing  them. 

The  company  which  makes  the  guarantee  should  be  en- 
tirely independent  of  the  company  issuing  either  the  bonds  or 
the  mortgages.  Not  infrequently,  the  title  of  the  bonds  and 
that  of  the  underlying  mortgage  will  be  guaranteed  by  dif- 
ferent but  inter-related  companies  controlled  by  the  same 
group  of  individuals.  It  would  greatly  add  to  the  value  of 
the  security  if  these  guarantees  were  made  by  independent 
companies  controlled  by  different  interests.  If  the  issuing 
companies  are  weak,  it  can  easily  be  seen  that  in  a  strained 
market  this  interlocking  of  control  has  a  cumulative  effect 
upon  the  stability  of  the  bonds.  The  usual  charge  for  this 
guarantee  is  one-half  of  one  per  cent.  The  company  gener- 
ally guarantees  to  pay  the  interest  on  each  interest  paying 
date,  but  does  not  always  guarantee  the  principal  on  the  date 
of  maturity.  It  provides  for  a  lapse  of  from  six  to  eighteen 
months,  after  the  maker  has  defaulted,  in  which  to  meet  its 
obligation.  This  is  a  detail  that  is  often  overlooked  by  the 
purchaser  of  these  bonds,  and  well  illustrates  the  necessity  of 
a  close  scrutiny  of  the  mortgage. 

The  same  distinctions  must  be  adhered  to  in  the  acceptance 
of  the  value  of  guaranteeing  companies  as  with  other  corpora- 
tions. One  of  the  oldest  and  largest  of  the  New  York  guar- 
antee mortgage  companies  has  been  in  existence  for  more  than 
thirty  years.  This  company,  however,  has  confined  its  loans 
to  New  York  City,  but  for  this  company  to  have  successfully 
weathered  the  depression  following  the  panic  of  1893,  as  well 
as  the  fifteen  year  decline  in  real  estate  prior  to  the  present 
rise  in  real  estate  value,  would  seem  an  ample  test  of  its 
strength.  With  the  record  of  an  experience  of  this  character, 
together  with  a  proper  ratio  between  the  capital,  surplus  and 
undivided  profits  possessed  by  the  company  to  the  value  of 


REAL  ESTATE  BONDS  501 

the  guaranteed  mortgages,  we  have  a  sound  basis  upon  which  to 
judge  the  value  of  the  guarantee. 

The  amount  of  the  mortgages  which  a  company  can  guar- 
antee should  be  closely  observed.  The  aggregate  amount  of 
mortgages  guaranteed  by  some  companies  is  limited  by  their 
charter  and  by-laws  to  twenty  times  their  capital.  (The  com- 
parison here  of  capital  should  include  capital,  surplus  and 
undivided  profits,  as  already  stated.)  This  provision  has  been 
borrowed  from  some  of  the  European  mortgage  companies 
which  have  had  a  long  and  unusual  experience.  A  number  of 
the  American  companies,  however,  have  placed  no  limit  on 
their  guarantees  and  in  a  number  of  cases  they  are  appar- 
ently guaranteeing  altogether  too  large  an  aggregate  amount 
of  mortgages.  For  example,  if  a  company  is  guaranteeing  a 
total  of  $100,000,000  mortgages  on  a  capital  surplus  and  un- 
divided profits  of  $3,000,000  to  $5,000,000,  it  will  readily  be 
seen  that  if  anything  really  happened  to  real  estate  values  in 
the  localities  in  which  these  companies  are  operating,  the  value 
of  the  guarantee  would  not  amount  to  much.  If  the  mortgage 
guarantee  companies  have  to  purchase  the  less  desirable  mort- 
gages in  order  to  secure  the  gross  rate  of  interest  which  it  is 
necessary  for  them  to  obtain,  the  weakness  of  the  guarantee 
is  apparent.  The  savings  banks  and  insurance  companies  are 
usually  ready  to  take  the  highest  grade  of  mortgages  at  less 
than  some  of  the  guarantee  companies  could  afford  to  pay. 
Consequently  these  particular  companies  are  forced  to  take 
issues  that  are  undesirable  from  a  purely  investment  point  of 
view  in  order  to  make  a  profit.  Furthermore,  each  company  as 
a  rule  operates  in  only  one  city,  and  its  risks  are,  therefore,  not 
spread  out  in  different  parts  of  the  country,  but  only  in  differ- 
ent parts  of  the  same  city.  The  worth  of  a  large  number  of 
these  guarantee  companies  as  a  protection  to  the  investor  has 
been  very  much  overestimated. 

Leasehold  Mortgage  Bonds. — Leasehold  mortgage  bonds 
with  a  few  exceptions  have  had  neither  a  long  nor  enviable 
record  in  this  country.  Leasehold  mortgage  loans  are  prohib- 
ited by  law  in  most  European  countries.  The  unhappy  ex- 
perience of  more  than  a  quarter  of  a  century  ago  of  insurance 


502  INVESTMENT  ANALYSIS 

companies  and  mortgage  bankers  led  to  the  rejection  of  lease- 
hold issues  by  these  institutions.  Certain  exceptions  to  this 
exist,  as  in  Chicago  in  such  centrally  located  business  property 
under  the  old  leases,  where  the  land  value  has  had  a  more  than 
normal  rise  in  value.  This  is  the  exception  and  not  the  rule, 
and  conservative  mortgage  bankers  everywhere  are  opposed 
to  this  form  of  security. 

"The  mortgage  on  a  leasehold  is  in  the  nature  of  a  second 
mortgage,  the  annual  charge  of  ground  rent  under  a  leasehold 
corresponding  to  the  interest  paid  on  the  first  mortgage."  If 
the  lease  happens  to  be  a  recent  one,  the  full  value  is  absorbed 
in  the  ground  rent  and  the  building  is  the  security.  "Where  a 
marked  rise  has  taken  place  upon  a  central  business  property 
that  has  but  a  small  prior  lien  and  the  lease  is  not  subject  to 
revaluation,  such  a  bond  would  be  valuable  security.  But 
again,  this  is  the  rare  exception  and  not  the  rule. 

The  method  of  issuing  these  bonds  does  not  vary  from  that 
employed  for  the  issuance  of  railroad  bonds.  An  individual 
or  corporation  leases  a  locality  in  the  business  area  of  a  large 
city,  but  does  not  have  sufficient  funds  to  finance  the  building 
project.  If  the  proposed  builder  can  show  to  the  underwriter 
that  the  new  or  improved  building  will  yield  a  sufficient 
income  from  the  rents  to  meet  the  charges  of  the  lease  and 
interest  charges  upon  the  proposed  notes,  mortgages,  or  mort- 
gage bond  issues,  the  underwriter  will  agree  either  to  sell  or 
underwrite  an  issue  whose  security  is  based  upon  the  lease  of 
the  property  held  by  the  proposed  builder.  In  the  issuance  of 
the  bonds  upon  a  lease,  this  lease  is  assigned  to  a  trustee  as 
security  for  the  bond  issue.  The  lease  must,  of  course,  extend 
a  considerable  number  of  years  beyond  the  maturity  of  the 
bonds. 

Installment  Payment  Plans. — Certain  real  estate  invest- 
ment companies  have  originated  various  installment  plans  to 
induce  people  with  small  incomes  to  invest.  As  the  business  is 
all  done  by  magazine  advertising,  the  cost  of  issuance  is  mate- 
rially reduced  and  affords  ample  profit  to  the  company.  There 
are  a  great  many  variations  in  the  details  of  these  various 
plans,  though  the  general  principles  are  much  the  same. 


REAL  ESTATE  BONDS  503 

When  a  company  called  "A"  receives  the  first  payment, 
which  may  range  from  $5.00  to  $25.00,  it  purchases  from  an 
affiliated  company  "B"  a  bond  for,  say,  $200.00  and  holds  it 
for  the  period  during  which  the  installments  are  being  paid. 
For  the  amount  paid  in,  the  investor  "A"  receives  a  certifi- 
cate or  receipt  which  is  credited  with  interest  every  six  months. 
If  the  payments  are  to  be  made  monthly,  at  say  the  rate  of 
ten  dollars  a  payment,  at  the  end  of  nineteen  months  the 
$200.00  would  have  been  paid  in  by  the  investor  for  the  bond, 
and  company  "A  ".would  now  exchange  the  certificates  held 
by  the  investor,  for  the  bond  it  has  held  of  the  issuing  com- 
pany "B."  This  bond  runs  for  a  definite  period  ranging  from 
five  to  twenty-five  years  and  draws  interest  semi-annually.1 
Where  the  transactions  are  carried  on  by  one  company,  the 
certificates  are  issued  directly  to  the  investor  and  exchanged  for 
bonds  when  all  payments  have  been  made.  These  payments  can 
be  on  an  annual,  semi-annual  or  quarterly  basis.  The  rates  of  a 
$1,000  bond  as  given  in  the  circulars  of  one  company,  are 
as  follows: 

Total  Amount 

Semi-  of  Annual          Maturity 

Maturing  in       Annual      Annual     Quarterly     Payments  Value 

10  Years         $71.57  36.32          $18.30          $715.70          $1,000.00 

15  Years  40.53  20.57  10.36  607.95  1,000.00 

20  Years  25.65  13.02  6.56  513.00  1,000.00 

Trust  Agreement  of  the  Company.  —  To  insure  the  conserva- 
tiveness  of  the  mortgage  bond  company  issuing  the  bonds,  the 
following  requirements  should  be  included:  (1)  that  the  mort- 
gage deposited  shall  always  be  a  first  lien  on  city  property  of 
a  minimum  size;  (2)  that  the  margin  of  loans  in  cities  of  cer- 
tain sizes  shall  be  stated;  (3)  that  the  percentage  of  mortgages 
issued  in  cities  under  one  million,  shall  not  exceed  a  given 
percentage  of  the  total  bonds  issued  by  the  company;  (4)  that 
a  single  bond  issue  shall  not  be  allowed  to  exceed  a  given  per- 
centage of  the  capital  stock  and  surplus  of  the  company;  (5) 
that  the  appraisals  shall  be  adequately  made;  (6)  that  com- 


plan  is  based  on  suggestions  taken  from  the  one  used  by  the 
Title  Guarantee  and  Trust  Company  of  New  York  City. 


504  INVESTMENT  ANALYSIS 

panies  operating  in  city  real  estate  bonds  shall  not  operate 
in  farm  mortgage  bonds  or  vice  versa;  (7)  that  no  real  estate 
must  be  acquired  except  from  foreclosure  and  must  be  dis- 
posed of  within  a  given  time;  (8)  that  the  taxes  will  be 
assumed  by  the  borrower;  (9)  that  a  two-thirds  vote  of  the  trus- 
tees will  be  required  before  underwriting  any  bond  issue; 
and  (10)  that  the  company  shall  guarantee  and  shall  take  all 
necessary  action  in  the  guarding  of  the  investors'  rights  and 
interests. 

The  statutes  regulating  these  companies  in  the  United  States 
are  still  in  need  of  very  large  revision.  The  majority  of  these 
companies  are  organized  under  the  general  banking  laws  of  the 
state  which  do  not  adequately  protect  the  investor's  interests  in 
mortgage  securities.  Modification  of  the  European  statutes, 
which  are  extremely  simple  in  form,  but  far  reaching  in  the 
protection  they  offer  to  the  investor,  will  undoubtedly  sooner  or 
later  be  adopted  in  this  country. 

Convertibility. — Eeal  estate  bonds  will  never  possess  the  de- 
gree of  convertibility  enjoyed  by  public  utilities  and  municipal 
bonds,  though  they  will  unquestionably  have  greater  negotia- 
bility with  the  wider  use  and  distribution  of  these  securities. 
Eeal  estate  securities  under  the  present  form  of  issuing  on  rela- 
tively small  local  property  holdings,  as  compared  to  public  util- 
ities, cannot  have  all  the  ideal  elements  of  a  perfect  investment 
possessed  by  a  bond  on  the  highest  class  railroad.  Each  indi- 
vidual piece  of  property,  whether  in  New  York  City,  New  York, 
or  Madison,  Wisconsin,  or  Cheyenne,  Wyoming,  or  Los  Angeles, 
California,  is  affected  by  conditions  peculiar  to  that  particular 
locality.  For  a  New  York  investor  with  $5,000,  to  investigate  a 
bond  offered  on  a  Cheyenne  property,  or  a  Los  Angeles  investor 
with  a  similar  amount  to  investigate  a  Madison  property  would 
not  be  warranted  because  of  the  costs  involved.  If  the  investor, 
on  the  other  hand,  is  purchasing  a  railroad  security,  not  only 
has  he  a  standardized  report  from  which  to  obtain  his  basic  in- 
formation, but  the  other  general  information  needed  to  make  an 
analysis  complete  can  be  procured  in  any  important  city  in  the 
country.  The  issue  is  large,  and  consequently  the  market  is 
broader. 


REAL  ESTATE  BONDS  505 

As  the  large  real  estate  bond-banks  in  the  principal  cities 
increase  in  number,  they  will  to  a  measure  overcome  the  diffi- 
culties of  the  market  problem  for  the  local  real  estate  bonds. 
To  what  extent  they  will  be  able  to  broaden  the  market  nation- 
ally for  these  bonds  is  still  problematic.  A  few  of  the  large 
real  estate  bond  bankers  have  begun  to  establish  branches 
throughout  the  important  cities  of  the  country,  and  it  is  only 
in  this  way  that  the  problem  can  be  solved.  But  although  this 
develops  a  broader  market  for  the  individual  banker's  own 
securities,  it  does  not  follow  that  a  broader  market  is  being 
created  for  the  bonds  of  other  real  estate  bond-bankers.  And 
it  is  only  when  one  banker  is  ready  and  willing  at  any  time  to 
purchase  the  securities  of  another  banker  that  a  broad  national 
market  such  as  is  possessed  by  active  investment  railroad  bonds 
will  be  created. 

Experience  has  shown  that  there  is  a  clogging  of  the  mar- 
ket and  a  lack  of  ready  negotiability  of  these  securities  in  a 
strained  market.  This  condition  is  more  particularly  true  of 
debenture  bonds  as  a  class  than  of  real  estate  bonds,  though  the 
strength  of  the  issuing  company  and  the  property  underlying 
the  securities  may  often  enable  the  debenture  bonds  to  maintain 
locally  a  comparatively  strong  market.  As  long  as  the  security 
exists  and  the  borrower  is  able  to  pay  at  maturity,  the  investor 
to  whom  convertibility  or  the  hypothecation  privilege  is  not  nec- 
essary, need  not  give  much  consideration  to  the  latter  features. 

In  order  to  provide  against  the  objections  raised  in  the 
previous  paragraph,  a  number  of  real  estate  companies  issuing 
debentures  allow  the  holder  to  redeem  his  bond  after  a  stipu- 
lated period  from  the  time  of  purchase.  But  where  this  privi- 
lege is  taken  advantage  of,  only  3  per  cent  interest  is  allowed 
for  the  period  during  which  the  bond  has  been  held.  This 
nullifies  any  advantage  that  the  redemption  privilege  would 
have.  Any  large  demand  for  redemption  in  a  period  of  strain 
might,  however,  prove  the  undoing  of  the  company,  for  it  would 
be  forced  to  dispose  of  its  property  in  order  to  secure  funds.  If 
a  large  part  of  its  assets  were  in  mortgages,  they  could  not  be 
disposed  of  in  such  a  period,  and  redemption  would  become 
impossible. 


506  INVESTMENT  ANALYSIS 

Other  Miscellaneous  Characteristics. — Where  mortgages  and 
mortgage  bonds  are  exempt  from  taxation,  they  command  a 
relatively  much  better  market.  The  most  frequent  nominal 
rate  has  been  7  per  cent,  though  much  higher  actual  rates  are 
reported  where  large  commissions  are  charged.  Because  of  the 
effort  to  appeal  to  the  small  investor,  a  very  large  number  of 
real  estate  bonds  are  issued  in  small  denominations.  The 
denominations  are  $100,  $200,  $500,  $1,000,  $5,000,  $10,000 
and  multiples  of  $5,000.  The  duration  of  these  bonds  ranges 
from  five  to  twenty-five  years,  though  it  averages  ten  to  fifteen 
years.  The  majority  are  callable  after  two  to  five  years  from 
the  date  of  issue,  at  a  very  slight  premium,  and  a  number  of 
companies  call  a  considerable  number  of  their  issues  before 
maturity. 

The  limitation  of  the  market  prevents  any  wide  fluctuation 
in  price.  "When  the  market  for  real  estate  securities  collapses, 
as  in  1907,  the  price  has  often  been  automatically  checked  at  a 
certain  level  because  of  the  lack  of  bidders.  In  a  well  secure^ 
issue,  however,  this  failure  to  respond  to  extreme  market 
changes  is  of  no  consequence  to  an  investor  purchasing  to  hold 
till  maturity. 


CHAPTER  XXX 

FARM  MORTGAGES  AND  FEDERAL  FARM  LOAN 

BONDS 

History  of  Development. — The  rapid  development  in  the 
West  and  North  after  1865,  brought  on  a  nation-wide  speculation 
in  land.  As  a  consequence,  land  values  were  greatly  inflated. 
These  inflated  values,  which  gave  additional  margins  to  borrow 
upon,  induced  many  investors  to  purchase  more  land  and  to 
make  more  improvements  with  hope  of  additional  profits.  This 
movement  continued  through  the  decade  of  1879  to  1890.1  Loan 
brokerage  companies  were  organized  in  the  East  and  West  to 
place  the  loans,  and  huge  commissions  were  reaped  at  both  ends. 
Investors,  attracted  by  the  high  interest  rates  and  the  reports 
of  unlimited  wealth  in  the  West,  offered  more  money  at  times 
than  could  be  placed.  Agents  would  induce  individuals  to  make 
loans  on  worthless  lands  for  the  sake  of  the  fees.  Clerks  who 
represented  agents  in  the  East  and  did  not  know  "sand  hill 
pastures"  from  "bottom  land/'  would  take  charge  of  making 
these  loans  and  appraising  the  lands.  Many  companies  held  the 
original  mortgages  and  issued  debentures  which  were  purchased 
as  eagerly  as  were  the  mortgages.  And  to  encourage  further 
purchases,  the  mortgage  brokers  would  guarantee  loans. 

Overproduction  was  followed  by  a  collapse  in  prices,  and 
Western  Kansas  and  Nebraska  at  the  same  time  suffered  from 
hot  winds  for  several  seasons.  In  five  years,  more  than  a  quar- 
ter of  a  million  of  the  inhabitants  of  these  states  moved  out, 


interesting  references  to  the  indebtedness  and  value  of  farms  in 
about  1890  are  to  be  found  in  the  United,  States  Census  in  the  Special 
Report  on  Farms  and  Homes.-  Proprietorship  Indebtedness.  See  also 
James  Willis  Gleed,  Forum,  ix  (March,  1890),  pp.  94-105. 

For  a  good  general  discussion  of  Farm  Mortgages  see  Kingman  Nott 
Robins,  Hand  Book  on  Farm  Mortgages,  Doubleday,  Page  &  Co.  (1916) 
pp.  271. 

507 


508  INVESTMENT  ANALYSIS 

leaving  heavily  mortgaged  farms.  The  mortgages  were  far  in 
excess  of  the  value  of  the  farm  lands  and  the  investors  came 
back  upon  the  companies  guaranteeing  these  mortgages,  which 
in  turn  passed  into  receivers'  hands.  But  those  farms,  of  which 
a  large  number  were  of  poor  quality,  were  of  little  worth  to 
European  and  Eastern  investors  who  in  many  cases  did  not 
even  know  their  location.  Millions  of  dollars  were  lost,  and  as 
a  result,  the  sale  of  farm  mortgages  to  individual  investors 
suffered  severely  for  a  number  of  years.  But  with  the  recovery 
at  the  close  of  the  previous  century  the  sale  of  farm  mortgages 
developed  on  a  rapid  and  sound  basis. 

The  rapid  recovery  and  increase  in  production  after  189G, 
together  with  the  subdivision  of  large  tracts  into  small  holdings 
in  the  South  and  far  "West,  made  the  very  large  increase  of 
mortgage  indebtedness  possible.  The  geographical  distribution 
of  these  mortgages  has  been  somewhat  irregular.  The  depend- 
ence of  the  Southern  farmer  on  personal  credit  and  his  aver- 
sion to  fixed  debt,  the  lack  of  standardization,  the  methods  of 
tenancy,  the  continued  ownership  of  large  tracts,  the  infre- 
quency  of  transfer,  low  land  values,  large  homestead  exemp- 
tions, and  inadequate  laws  for  the  protection  of  the  creditor — 
all  these  have  resulted  in  a  very  limited  use  of  mortgage  debts 
in  the  South.  The  Southern  Central  States,  for  example,  have 
less  than  10  per  cent  of  their  farms  mortgaged,  while  the  West- 
ern Central  States  have  45  to  50  per  cent  mortgaged.  Changes 
in  the  South,  however,  have  been  rapidly  taking  place  in  the 
transfer,  size  of  tracts,  and  methods  of  cultivation,  though  home- 
stead exemptions  and  laws  protecting  the  debtors  have  not  been 
materially  changed.  These  have  resulted  in  a  great  increase  in 
the  number  of  tracts  mortgaged,  but  the  total  number  is  still 
small.  For  the  United  States  as  a  whole,  it  is  estimated  that 
the  amount  of  farm  mortgages  now  outstanding  is  approxi- 
mately $5,000,000,000  with  property  assessed  at  $75,000,000,000.* 

Increase  in  Land  Values. — Farm  land  values  as  a  class  have 
increased  more  rapidly  in  many  sections  of  the  United  States 


K).  M.  Corwin,  Vice-President  of  Wells-Dickey  Co.,  Minneapolis,  in 
an  address  before  the  Minnesota  State  Convention  of  Realty  Owners  and 
Dealers  Association,  St.  Paul,  January  15,  1920. 


FAKM  MORTGAGES  509 

than  city  land  values.     This  increase  must  be  largely  assigned 
to  the  active  buying  and  selling  of  farm  property  and  the 
increase  in  prices,  which  has  affected  farm  products  more  than 
any  other  class  of  production.    The  chief  gains  in  farm  values, 
as  would  be  expected,  have  been  in  the  West.     The  greater 
part  of  this  increase,  however,  contrary  to  the  common  belief, 
has  not  been  in  the  value  of  new  improved  acreage.1     On  the 
basis  of  this  increase  in  the  value  of  farms,  the  claim  is  made  in 
the  advertising  literature  of  many  mortgage  banks,  that  the 
equity  of  the  farmer  is  greater  now  than  in  1890,  as  the  mort- 
gage indebtedness  has  decreased  to  a  small  fraction.     But  the 
value  of  a  farm  as  a  going  concern  must  be  measured,  like 
that  of  any  business  corporation,  on  the  basis  of  its  net  profits. 
An  increased  equity  without  increased  income  will  give  the 
farmer  a  gain  if  he  wishes  to  sell,  but  the  gain  from  the  sale  is 
of  no  ultimate  value  if  the  general  price  level  has  advanced.    A 
purchaser  of  the  land  is  worse  off  with  this  increase  in  land 
values,   if  the   income   from   the   land   has  not   relatively  in- 
creased, because  the  burden   of  the  funded  debt  has  become 
relatively  greater.     At  the  present  price  of  land,  the  purchase 
of  small  land  holdings  in  certain  localities  of  the  United  States 
has  become  an  almost  impossible  undertaking,  if  it  is  necessary 
to  resort  to  borrowing  and  only  short  term  loans  are  to  be  had. 
Where  a  long  termed  mortgage  was  issued  at  the  beginning 
of,  or  prior  to,  this  rise  in  land  values,  an  increased  security 
has  accrued  to  the  mortgage  holder.    The  only  advantage  to  the 
owner  of  this  mortgage,  if  he  retains  it,  is  the  increased  secur- 
ity; and,  if  he  wishes  to  sell,  a  possible  profit,  provided  the 
mortgage  was  originally  issued  at  a  favorable  rate.     To  a  short 
term  mortgage,  a  very  slight,  if  any  advantage  has  accrued. 

Location  and  Distribution. — The  distribution  of  farm  mort- 
gages (the  reader  should  bear  in  mind  that  mortgages  and  not 
bonds  are   discussed  in  this  chapter  unless  specifically  men- 
Tor  further  information  on  this  topic  see  George  K.  Holmes,  Year- 
look  of  the  Department  of  Agriculture  (IT.  S.,  1905),  pp.  511-521. 

L.  W.  Ellis,  Bulletin  212,  Bureau  of  Plant  Industry,  Department  of 
Agriculture  (U.  S..  pp.  12-13). 

2Richard  T.  Ely,   Outline  of  Economics    (Capitalization  of   Rent), 
pp.  359-360  (1909). 


510  INVESTMENT  ANLYSIS 

tioned)  with  the  exception  of  the  purchases  made  by  large 
mortgage  banks  and  insurance  companies,  is  still  largely  local- 
ized. The  insurance  companies,  which  are  by  far  the  largest 
single  class  of  purchasers,  hold  an  amount  equal  to  about  20 
per  cent  of  that  held  by  the  banks.1  The  distribution  of  their 
purchases,  however,  is  in  very  definite  areas. 

Mr.  George  T.  Wight,  in  an  address  on  the  investment  of 
life  insurance  companies,  stated:  "These  figures  show  that  the 
radical  trend  toward  real  estate  mortgage  loans  that  stood  as 
the  dominant  feature  of  the  period  from  1904  to  1914  is  still 
noticeable  in  the  experience  of  the  companies  in  1915  and  1916.* 
The  mortgage  loans  increased  from  $670,000,000  in  1904  to 
$1,700,000,000  in  1914,  or  more  than  150  per  cent.  Where  in 
1904  they  amounted  to  27  per  cent  of  all  assets  they  jumped  to 
34%  per  cent  in  1914.  Two  years  later  we  find  them  about 
$190,000,000  more,  although  there  is  a  very  slight  downward 


Robert  Lynn  Cox,  Report  to  the  Ninth  Annual  Meeting  of  the 
Association  of  Life  Insurance  Presidents,  December  9,  1915,  vol.  ix. 
The  last  United  States  Census  gave  the  holdings  of  farm  mortgages  by 
Life  Insurance  Companies  as  37%  per  cent  of  the  total. 

2In  referring  to  the  amount  of  farm  mortgages  held  by  life  insurance 
companies,  Mr.  Wight  states,  "It  is,  of  course,  more  than  a  mere  co- 
incidence that  over  95  per  cent  of  the  total  life  insurance  farm  mort- 
gages and  nearly  95  per  cent  of  the  increase  shown  in  1916  over  1914 
and  94  per  cent  of  new  of  1917  are  located  in  this  group  of  states  con- 
taining 50  per  cent  of  the  area,  47  per  cent  of  the  population,  48.8  per 
cent  of  the  wealth  of  the  country  as  estimated  by  the  United  States 
Census  Bureau." 

The  states  included  in  the  above  percentages,  together  with  the 
amounts  of  mortgages  held  by  Life  Insurance  Companies  in  1916,  are 
as  follows: 

Amount  of  Amount  of 

State  Mortgages        State  Mortgages 

Iowa  $195,000,000      Ohio    $19,000,000 

Missouri    73,000,000      Georgia  19,000,000 

Kansas     70,000,000       North  Dakota    18,000,000 

Nebraska 65,000,000      Tennessee 13.000,000 

Indiana    56,000,000      California   12,000,000 

Illinois 55,000,000       Kentucky 10,000.000 

Texas   49,000,000      So.  Carolina .  (nearly  6)     5,000.000 

Minnesota   43,000.000      Montana    5,000,000 

South  Dakota 41,000,000      Arkansas  5,000,000 

Oklahoma    31,000,000 

(George  T.  Wight,  Life  Insurance  Farm  Loan  Investments  in  War 
Time,  A  Report  Transmitted  to  Life  Insurance  Companies  of  the  United 
States,  August  26,  1918,  by  Mr.  Wight  as  Secretary  and  Manager  of  the 
Association  of  Life  Insurance  Presidents,  pp.  7-9.) 


FARM  MORTGAGES  511 

fluctuation  in  their  ratio  to  total  assets,  for  the  twelve  years, 
in  all  we  find  the  rate  of  increase  in  the  case  of  mortgages  (182 
per  cent)  is  much  larger  than  the  rate  of  increase  (116  per 
cent)  for  corporation  bonds."  An  examination  of  the  offerings 
made  by  the  conservative  mortgage  bankers  will  show  that 
their  offerings  also  are  confined  to  the  same  areas  in  which 
insurance  companies  make  their  purchases. 

A  number  of  mortgage  bankers  are  beginning  to  advertise 
widely  through  the  popular  magazines,  and  are  building  up  a 
considerable  clientele,  but  the  amounts  marketed  by  these  banks 
are  small  compared  to  the  purchases  of  the  insurance  com- 
panies. These  offerings  are  sold  to  small  investors  and  conse- 
quently total  very  slowly  into  large  amounts.  It  should  be 
noted  in  passing,  that  considerable  discrimination  should  be 
used  in  choosing  from  among  these  advertisers,  for  there  are 
other  than  conservative  bankers  in  the  list. 

The  fact,  however,  remains  that  the  largest  number  of 
these  obligations  are  distributed  within  less  than  one  hundred 
miles  of  the  mortgagor.  The  small  units  and  the  comparatively 
high  cost  of  obtaining  reliable  information  as  to  their  security, 
limits  these  offerings  to  distribution  in  local  areas,  and  this 
must  continue  for  a  considerable  length  of  time  in  the  majority 
of  localities.  The  care  which  the  insurance  companies  and  con- 
servative bankers,  in  order  to  insure  safety,  have  exercised  in 
the  examination  of  these  localities  should  be  the  basis  used  by 
the  investor  for  the  first  general  selection  of  these  securities. 

Classes  of  Farm  Securities. — The  classes  of  farm  mort- 
gages are  identical  to  those  described  under  Real  Estate  Mort- 
gages. Excepting  for  the  Federal  Bonds  discussed  later  the 
issuance  of  bonds  on  farm  mortgages  is  as  yet  very  limited  in 
the  United  States.  The  short  maturity  of  the  farm  mortgage 
under  the  private  company  issuance  has  been  a  drawback  to  the 
development  of  bond  issues.  A  few  companies  are  now  issuing 
the  debenture  and  collateral  and  trust  mortgages.  As  in  real 
estate  debentures,  certificates  of  small  amounts  are  issued  and 
exchanged  for  debentures  in  denominations  of  $100,  $200,  and 

»/&*•&,  P.  3. 


512  INVESTMENT  ANALYSIS 

$500.  In  the  large  mortgages,  certificates  of  varying  denomina- 
tions are  issued  against  a  mortgage  deposited  with  a  trustee. 
Guarantees  are  frequently  made  when  these  mortgages  are  as- 
signed to  the  purchaser,  but  the  value  of  these  vary  as  is  the 
case  of  all  such  guarantees,  with  the  stability  and  integrity  of 
the  underwriting  company.  A  few  companies  are  making 
issues  of  Amortization  Mortgages  or  Bonds,  which  are  copied 
after  similar  issues  made  in  Europe.  The  loans  are  repaid  to 
the  underwriting  company  in  small  semi-annual  payments,  these 
payments  including  both  the  interest  and  a  stipulated  propor- 
tion of  the  principal,  which  amounts  depend  on  the  term  that 
the  mortgage  has  to  run.  In  Europe,  many  of  these  mortgages 
run  for  twenty-five  years.  If  a  loan,  for  example,  were  issued 
for  $1,000  for  30  years  at  5  per  cent  per  annum,  a  payment  of 
$35.00  every  six  months  for  thirty  years  would  completely  ex- 
terminate the  debt.  This  plan  has  also  been  copied  in  the  Fed- 
eral Farm  Loan  Act  which  is  discussed  later.  The  instrument, 
however,  purchased  by  the  investor  is  a  bond  secured  by  the 
farm  mortgage  and  not  the  farm-mortgage  itself,  to  which  the 
discussion  of  this  chapter  is  devoted. 

Bonds  or  certificates  under  this  plan  are  issued  by  the  un- 
derwriting company  against  these  mortgages.  The  usual  regu- 
lations covering  the  issuance  of  these  bonds  are  the  same  as  for 
the  ordinary  debenture  bonds.  The  underwriters  agree  that 
they  will  always  keep  a  certain  amount  of  mortgages  with  the 
trustee  in  excess  of  the  bonds  issued  against  the  mortgages.  The 
borrower  usually  has  the  privilege  of  anticipating  any  number 
of  the  payments  that  he  desires,  in  addition  to  his  regular  pay- 
ments. 

Physical  Appraisement. — "Public  opinion,"  states  one  well 
known  mortgage  banker  of  the  Middle  West,  "swings  from  one 
extreme  to  another."  It  is  not  many  years  since  farm  mort- 
gages were  in  exceedingly  bad  repute,  not  because  there  was 
anything  inherently  hazardous  in  a  good  farm  mortgage,  but 
because  the  demand  for  them  led  the  investors  to  place  their 
money  in  semi-arid  portions  of  the  West,  where  lack  of  rainfall 
made  it  impossible  to  grow  crops  successfully  each  year.  At 
the  present  time  the  public  has  swung  to  the  other  extreme, 


FARM  MORTGAGES  513 

and  little,  if  any,  criticism  is  ever  heard  of  this  form  of  invest- 
ment— a  condition  which  certainly  must  often  result  in  the 
safety  of  these  securities  being  accepted  without  sufficient 
investigation. 

As  much  expert  skill  is  necessary  to  be  able  to  judge  the 
security  underlying  farm  mortgages  as  to  judge  the  security 
of  any  other  form  of  investment,  and  the  valuation  should  be 
made  by  an  appraiser  independent  of  the  agency  issuing  the 
mortgage.  A  locality  where  loans  are  highly  desirable  and  even 
sought  after  may  adjoin  a  locality  in  which  few,  if  any,  good 
loans  could  be  procured.  Farming,  it  must  not  be  forgotten,  is  a 
business,  and  in  order  to  carry  a  loan  to  a  successful  maturity 
it  is  as  essential  for  the  farmer  to  possess  business  acumen  and 
managerial  ability  as  it  is  for  the  executive  officer  of  a  corpora- 
tion to  have  these  qualities.  Though  land  is  imperishable  and 
cannot  vanish,  something  more  than  imperishability  is  required 
to  insure  its  making  a  return  on  funds  invested  in  it. 

Fundamentally,  the  farm  must  not  only  have  the  potential 
qualities  for  productiveness  but  must  actually  be  producing 
to  be  a  valuable  basis  for  a  security.  While  an  investor  is 
constantly  mindful  of  the  quality  of  the  potential  security,  he 
is  equally  cognizant  of  the  fact  that  it  is  not  profitable  to  fore- 
close and  that  valuation  must  be  based  on  a  going  concern.  A 
physical  appraisement  of  a  farm  must  include:  (1)  the  number 
of  acres  and  the  general  usage  to  which  each  part  of  the  land 
is  put ;  the  acreage  fenced  and  if  irrigated  the  character  of  the 
water-rights;  (2)  the  character  of  the  soil,  subsoil,  and  drain- 
age; (3)  the  size,  kinds,  and  value  of  the  farm  equipment, 
buildings,  and  other  improvements;  (4)  the  value  of  livestock 
and  farm  equipments;  (5)  the  character  of  the  roads  and  dis- 
tance to  the  nearest  railroad  transportation;  (6)  a  financial 
statement  of  the  borrower  showing  his  assets  and  liabilities;  (7) 
the  general  character  of  the  neighborhood;  (8)  the  value  of 
the  land  exclusive  of  the  buildings/ 

A  statement  of  the  character  of  the  borrower  should  like- 
wise be  included.  The  moral  risk  is  larger  here  than  in  any 


aPearsons  Taft  Land  Credit  Company    (Pamphlet  on  Farm  Mort- 
gages), pp.  12  and  27. 


514  INVESTMENT  ANALYSIS 

other  type  of  security,  as  the  surety  of  production  is  dependent 
upon  one  individual.  The  purchaser  of  the  mortgage  must 
satisfy  himself  that  the  borrower  has  sufficient  interest  in  the 
property  to  continue  its  improvement  in  the  interim  of  making 
and  paying  the  loan,  as  this  will  insure  the  equity  behind  the 
mortgage  from  decreasing. 

Other  Miscellaneous  Factors. — Farm  mortgage  loans  range 
from  20  to  50  per  cent  of  the  value  of  the  land,  though  a  rela- 
tively small  number  are  as  high  as  50  per  cent;  and  for  a 
conservative  investment  it  is  questionable  whether  a  loan  on 
the  average  farm  should  ever  be  above  this  amount,  though 
certain  authorities  place  the  loaning  value  on  the  best  farms  as 
high  as  two-thirds  of  their  value.  A  larger  margin  than  50  per 
cent  is,  however,  desirable  for  the  conservative  investment. 
Where  buildings  constitute  a  large  part  of  the  security  offered, 
a  greater  margin  should  be  allowed  than  where  only  land  is  the 
security,  and  ample  insurance  should  be  provided  by  the  bor- 
rower. As  a  rule,  it  is  the  better  part  of  conservatism  not  to 
include  the  value  of  the  buildings  in  the  determination  of  the 
margins  for  loans.  Locality,  distance  to  market,  soils,  climate, 
etc.,  all  enter  into  the  determination  of  these  margins  of  safety. 

The  long  existence  of  mortgage  loans  in  Europe  has  devel- 
oped a  more  detailed  classification  of  property.  The  loans  on 
vineyards  never  exceed  33^  per  cent  on  average  farms,  and 
50  per  cent  on  good  farms,  though  many  loan  associations  fre- 
quently allow  as  high  as  75  per  cent  on  exceptional  property. 
Too  much  weight  should  not,  however,  be  given  to  European 
practice,  as  a  basis  for  loans  in  the  United  States.  The  methods 
of  intensive  cultivation  and  the  character  of  farm  organization 
used  there  are  foreign  to  this  country  except  for  truck  gar- 
dens in  the  vicinity  of  large  cities.  In  Europe  farm  communi- 
ties are  long  established  and  not  subject,  as  in  the  United  States, 
to  the  constant  readjustment  necessitated  by  the  division  of 
large  tracts  of  land. 

The  mortgage,  in  addition  to  a  detailed  list  and  valuation  of 
all  property  conveyed  under  the  instrument  and  the  declara- 
tion of  the  right  in  ownership  of  conveyance,  should  provide 
that  the  buildings  and  other  improvements  be  kept  in  good 


FARM  MORTGAGES  515 

repair,  and  be  insured  for  an  agreed  sum  by  a  company 
approved  by  the  mortgagee.  In  case  of  loss,  the  mortgagor 
should  agree  to  use  indemnity  in  rebuilding  or  repairing  dam- 
ages. Further  provisions  should  make  it  incumbent  upon  the 
mortgagor  to  pay  all  attorney's  fees,  cost  of  all  litigation  in- 
curred in  collecting  or  protecting  the  loan  from  foreclosure,  all 
taxes  and  assessments,  and  likewise  all  sums  advanced  by  the 
mortgagor  for  any  of  the  aforementioned  purposes.  And  if  a 
default  is  made  in  any  of  the  above  agreements  or  interest  pay- 
ments, the  mortgage  shall  be  declared  defaulted. 

The  most  common  and  greatest  objection  to  farm  mortgages, 
as  to  real  estate  in  general,  is  the  lack  of  convertibility  possessed 
by  bonds.  The  higher  class  of  farm  mortgages,  however,  during 
the  panic  of  1907  were  among  the  small  number  of  securities 
which  realized  full  value  upon  resale  without  the  loss  of  prin- 
cipal. A  few  of  the  best  companies  sustained  the  market  for 
their  own  mortgages  by  a  repurchase  of  them  whenever  nec- 
essary. 

During  normal  periods,  with  the  exception  of  the  autumn 
season,  farm  mortgages  can  usually  be  hypothecated  with  local 
banks.  Banks,  however,  outside  of  the  locality  in  which  a  mort- 
gage is  issued  are  reluctant  to  make  a  loan  on  it  excepting 
where  the  individual  or  organization  making  the  loan  com- 
mands considerable  resources.  With  the  modification  in  the 
new  national  banking  law,  the  general  credit  situation  for  farm- 
ers seeking  temporary  loans  should  be  improved.1  And  with 
the  eventual  perfecting  of  this  law,  this  objection  to  farm  loans 
should  be  greatly  modified  and  the  objections  which  now  exist 
largely  removed. 

The  disadvantage  of  the  short  termed  mortgage  has  already 
been  discussed  under  a  previous  heading  and  need  not  be  re- 
peated. The  average  maturity  of  mortgages  in  this  country  is 
five  years,  though  a  few  are  over  ten  years.  This  is  a  disadvan- 


"The  Federal  Reserve  Act,  Sec.  24  (Approved  December  23,  1913), 
and  as  amended  by  act  approved  Sept.  7,  1916  (39  Stat,  752  Chap.  461). 

Also  under  Sec.  13  of  this  act,  as  amended,  all  notes,  drafts  and  bills 
of  exchange  drawn  or  issued  for  agricultural  purposes  or  based  on  live- 
stock may  be  discounted  for  a  period  of  six  months  or  less.  See  topic 
on  Federal  Farm  Loan  Act. 


516  INVESTMENT   ANALYSIS 

tage  to  the  farmer,  for  if  the  loan  is  large  it  prevents  him  from 
paying  off  the  loan  from  the  profits  on  the  farm  during  or  at 
the  end  of  the  period  of  the  loan.  This  necessitates  the  renewal 
of  the  loan,  with  a  consequent  increase  in  the  costs  to  both  the 
farmer  and  the  investor.  Where  mortgages  are  longer  than  the 
average  maturity,  there  is  an  increasing  tendency  to  allow  the 
mortgage  to  be  retired  by  a  serial  method  of  payment. 

No  standard  denominations  exist  in  farm  mortgages.  Popu- 
lar demand  for  $500  denominations,  as  in  city  property  mort- 
gages, has  increased  the  practice  of  dividing  up  the  mortgages 
and  issuing  certificates  against  a  specially  deposited  mortgage. 

Period  of  Redemption  After  Foreclosure. — The  court  deci- 
sions bearing  upon  the  period  in  which  the  mortgagor  has  the 
right  to  redeem  the  land  after  the  mortgagee  has  taken  pos- 
session, are  not  clear.  In  most  jurisdictions,  the  right  to  redeem 
terminates,  as  in  New  York,  when  the  foreclosure  sale  is  com- 
pleted.1 The  right  of  redemption  after  forfeiture  is  provided 
for  in  some  states  by  statute;  these  allow  a  varying  range  of 
duration  which,  through  possible  extension,  may  be  drawn  out, 
as  has  been  the  case  in  Alabama  for  two  years.  The  courts,  as 
for  example  in  Illinois  (Anderson  vs.  Olingdon),  have  allowed 
extension  periods  of  from  six  months  to  two  years.2 

The  provisions  demanding  that  the  period  of  time  allowed 
to  elapse  between  the  foreclosure  of  the  property  and  its  sale 
shall  be  sufficient  to  permit  the  mortgagor  to  redeem  it,  devel- 
oped in  the  agricultural  states  to  prevent  farms  from  passing 
into  the  hands  of  creditors  where  the  non-payment  of  the  debt, 
when  due,  was  owing  to  crop  failure.  This  prevented  out- 
siders from  buying  up  foreclosures  and  the  mortgagee  from 
improving  the  property.  Where  the  mortgagor  is  allowed  to 
remain  in  control  during  the  period  of  redemption  allowed  by 
the  statute,  losses  to  the  investors  are  increased.8  Some  states, 


Stevens  vs.  Theaters  (1913),  Ch.  857;  also  see  L.  A.  Jones,  Treatise 
on  the  Law  of  Mortgages  (Ed.  1908),  Section  608. 

2C.  H.  Wiltsie,  A  Treatise  on  the  Foreclosing  of  Mortgages.  (Mort- 
gage Redemption,  Ch.  Prefaced  by  J.  M.  Kerr)  vol.  ii,  pp.  1464-1471 
(1913). 

3G.  A.  Hurd,  Annals  of  the  American  Academy  of  'Political  and 
Social  Science,  vol.  xxx,  Sept.,  1907,  p.  174. 


FARM  MORTGAGES  517 

especially  the  Southern  states,  have  been  more  liberal  in  the 
accumulations  of  back  charges  against  the  debtor  in  the  final 
settlement  of  his  mortgages.1  The  danger  of  losses  under  loose 
statutes  and  decisions  will  probably  be  very  much  lessened  by 
the  decision  of  the  United  States  Supreme  Court  on  the  Kansas 
Statute  providing  that  mortgagors  should  have  eighteen  months 
in  which  to  make  redemptions.  This  was  declared  unconstitu- 
tional.' 

Farm  Loan  Bonds. — Considering  the  present  high  prices  of 
land,  as  well  as  fertilizer  and  equipment,  the  farmer  with  lim- 
ited means  is  placed  at  a  great  disadvantage  when  buying 
under  a  short  term  mortgage.  The  farmer  in  the  past  has 
been  expected  to  pay  for  his  equipment  within  from  six  months 
to  two  years,  and  yet  the  returns  on  this  investment  are 
stretched  often  over  a  period  of  fifteen  years.  How  long  would 
an  industrial  corporation  which  is  funding  30  or  40  per  cent 
of  its  capitalization  be  able  to  exist  under  this  method  of  financ- 
ing? As  long  as  new  land  could  be  acquired  so  cheaply  in  this 
country,  this  condition  was  not  a  serious  problem.  But  with 
free  land  practically  all  taken  and  land  values  increasing,  the 
situation  assumes  a  different  aspect,  especially,  if  small  farms 
are  to  be  developed  which  would  seem  the  logical  outcome  with 
the  increasing  demand  for  intensive  farming. 

Europe,  because  of  its  small  unit  farms,  was  forced  long 
since  to  adopt  the  principle  of  long  tenure  farm  mortgages. 
Out  of  this  one  hundred  and  fifty  years'  experience  the  mort- 
gage bankers  of  Europe  have  been  able  to  lay  down  four  estab- 
lished rules  for  the  issuance  of  long  time  mortgage  bonds:  (1) 
A  mortgage  to  be  accepted  must  have  such  requirements  as 
would  allow  it  to  be  placed  in  one  of  the  classes  of  a  standard- 
ized classification  of  mortgages;  (2)  there  must  be  a  standard- 
ized percentage  of  loan  value  for  the  various  kinds  of  property 
in  this  classification;  (3)  the  requirement  of  an  annual  serial 
payment  of  loans  must  be  met  so  that  the  possible  embarrass- 
ment of  the  farmer  may  be  lessened;  (4)  the  amount  of  the 
bond  issues  to  the  capital  stock  of  the  companies  is  legally  lim- 

JC.  H.  Wiltsie,  lUd,  p.  175. 

3Ibid.     (Quoted  paragraph  1465-1466)  Case  of  Banitz  vs.  Beverly. 


518  INVESTMENT  ANALYSIS 

i 

ited.  The  violation  of  this  last  principle  in  the  United  States 
has  caused  a  good  many  investors  in  debentures  to  come  to  grief. 
Among  other  regulations  adding  to  the  strength  of  the  Euro- 
pean securities  is  that  forbidding  the  banks  to  loan  on  vacant, 
property.  The  margins  allowed  between  bonds  and  mortgages 
are  so  small,  that  there  is  little  temptation  to  make  risky  loans. 
Foreclosed  property  must  be  immediately  sold  by  the  bankers. 
Surplus  is  treated  as  a  distinct  fund  and  net  profits  must  be  set 
aside  annually  until  they  reach  10  to  25  per  cent  of  the  capital 
of  the  mortgage  company. 

Too  much  emphasis,  however,  must  not  be  placed  upon  the 
European  experiences  for  the  immediate  needs  of  the  United 
States.  The  majority  of  the  loans  made  in  Europe  are  to  the 
peasant  class.  Relatively  speaking,  the  smallest  American  farm 
is  large  and  the  business  is  still  conducted  on  an  extensive  scale. 
Profits  are  likewise  much  larger,  so  that  payments  on  well  man- 
aged farms  can  be  made  in  a  brief  period  yet  with  less  burden 
than  is  possible  in  Europe  with  its  longer  period  of  payments. 

The  United  States  in  the  adoption  of  the  Eural  Credits  Act 
of  June  16,  1917,  for  the  first  time  has  given  national  recogni- 
tion to  long-time  credit,  and  payment  on  the  amortization  prin- 
ciples— two  provisions  which  are  needed  by  many  of  the  rural 
communities  of  this  country.  As  with  all  long  time  loans,  a  con- 
siderable amount  of  the  funds  must  be  obtained  from  the  issue 
of  bonds.  It  is  to  the  details  affecting  the  security  of  these 
bonds  and  the  equity  back  of  these  instruments  that  this  dis- 
cussion is  devoted,  rather  than  to  a  consideration  of  the  details 
involved  in  the  institutions  created  under  this  act,  excepting  as 
they  affect  these  two  problems. 

Neither  is  it  the  purpose  here  to  go  into  much  of  the  con- 
troversial matter  related  to  this  act.  All  certainly  are  agreed 
that  long  time  credit  is  needed,  but  whether  this  should  be  ex- 
tended wholly  by  private  institutions  under  general  govern- 
ment regulation  or  should  continue  to  be  granted  as  under  the 
present  system  is  a  controversial  matter  which  does  not  belong 
to  the  field  covered  in  this  book.  The  problem  confronted  in 
this  chapter  is — what  are  the  investments  offered  under  this 
act,  and  what  safety  do  they  possess? 


FARM  MORTGAGES  519 

The  Rural  Credits  Act  is  constructed  around  two  institu- 
tions known  as  the  Federal  Land  Bank  and  the  Joint  Stock 
Land  Bank,  both  under  the  control  of  a  Federal  Farm  Loan 
Board.  While  the  Joint  Stock  Land  Bank  is  under  the  general 
control  and  administration  of  the  Federal  Land  Board,  it  pos- 
sesses more  of  the  powers  of  a  private  corporation.  This  is 
illustrated  in  the  fact  that  the  loans  made  by  the  Joint  Stock 
Land  Bank  are  made  direct  to  the  farmer,  while  all  loans 
of  the  Federal  Land  Bank  are  made  directly  through  the  Na- 
tional Farm  Loan  Association  organized  by  the  borrowers  them- 
selves. On  the  other  hand,  the  intention  of  the  act  is  to  give 
the  control  of  the  Federal  Land  Banks  to  the  Farm  Loan 
Associations  when  these  associations  have  increased  in  suffi- 
cient number  and  size  to  own  all  of  the  capital  stock  of  the 
Farm  Land  Banks. 

By  the  provisions  of  the  act  the  Federal  Farm  Loan  Board 
was  originally  required  to  divide  continental  United  States  into 
twelve  districts.1  The  capital  stock  of  these  banks  must  not  be 
less  than  $750,000  and  divided  into  shares  of  $5.00  par  value. 
Individuals,  firms,  corporations,  and  any  state  or  the  Federal 
government  can  subscribe  for  the  stock.  The  provision  for  the 
Federal  government  subscription  to  the  capital  stock  was  made 
to  insure  the  establishment  of  the  bank.  The  voting  shares  are 
those  held  by  the  National  Farm  Association  (described  later) 
and  those  held  by  the  government.  As  rapidly  as  the  shares  are 
taken  up  by  the  National  Associations  they  will  be  relinquished 
by  the  government,  so  that  eventually  the  farmer  will  have  full 
voting  control.  Twenty-five  per  cent  of  all  subscriptions  above 
$750,000  shall  be  used  for  the  purpose  of  retiring  the  original 
capital,  and  thus  transfer  the  control  over  to  the  associations. 
At  least  25  per  cent  of  the  capital  stock  held  by  the  National 
Farm  Associations  shall  be  in  quick  assets,  and  at  least  5  per 
cent  in  United  States  government  bonds. 

All  loans  of  the  Federal  Land  Banks  are  to  be  made  on  first 


federal  Land  Banks  are  now  located  and  operating  in  Springfield, 
Massachusetts ;  Baltimore,  Maryland  ;  Columbia,  South  Carolina ;  Louis- 
ville. Kentucky ;  New  Orleans.  Louisiana ;  St.  Paul,  Minnesota ;  St. 
I.ouis,  Missouri;  Omaha,  Nebraska;  Wichita,  Kansas;  Houston,  Texas; 
Berkeley,  California ;  and  Spokane,  Washington. 


520  INVESTMENT  ANALYSIS 

mortgages  on  farm  lands  and  through  a  National  Farm  Asso- 
ciation, excepting  where  there  is  a  temporary  failure  to  estab- 
lish a  National  Farm  Association  or  Associations.1  These  as- 
sociations are  created  by  the  farmers  themselves  who  want  to 
become  borrowers  on  first  mortgages,  and  unless  a  farmer  is  a 
borrower  he  cannot  become  a  member  of  the  association.  When 
ten  or  more  land  owners  who  actually  operate  their  own  farms 
desire  to  secure  loans,  articles  of  association  required  by  the 
act  shall  be  drawn  up  and  be  approved  by  the  Federal  Land 
Bank  of  the  district.2  The  total  loans  shall  aggregate  not  less 
than  $20,000.  Each  member  must  also  subscribe  to  shares  ($5 
par)  in  the  association  to  the  amount  of  one  share  of  stock  to 
each  $100  of  loan  made.  These  shares  are  held  as  collateral 
security  for  the  loan  during  its  life,  but  at  its  maturity  they 
are  retired  at  par.  The  shareholders  are  subject  to  a  double 
liability,  i.  e.,  an  amount  equivalent  to  as  much  again  as  the 
amount  of  the  shares  held. 

When  the  National  Farm  Loan  Association  in  turn  must 
secure  funds  to  loan  to  its  members  it  must  subscribe  to  the 
capital  stock  of  the  loan  to  be  made.  This  stock  is  also  held  by 
the  bank  as  collateral  security  against  the  loan,  in  addition  to 
the  claims  against  the  farm  conveyed  to  the  bank  by  the  mort- 
gage. As  the  mortgage  is  endorsed  by  the  association,  it  also 
becomes  liable  for  the  default  in  any  interest  payment  or  prin- 
cipal of  the  loan.  As  already  stated,  the  loans  of  the  Joint 
Stock  Land  Bank  are  made  direct  to  the  farmer,  but  they  must 
conform  to  the  same  general  regulations  as  loans  advanced 
through  Federal  Land  Banks.  There  are  no  restrictions  placed 
upon  the  amount  which  these  latter  banks  can  loan  to  any  indi- 
vidual. 


'Sec.  15  of  Act  states:  "That,  whenever  this  Act  shall  have  been 
in  effect  one  year,  it  shall  appear  to  the  Federal  Farm  Loan  Board 
that  national  farm  loan  associations  have  not  been  formed  (etc.) — in  its 
discretion,  it  can  authorize  Farm  Land  Banks  to  make  loans  on  farm 
agents  approved  by  said  board."  Regulations  of  these  loans  are  the 
same  as  those  required  of  national  farm  loan  associations.  The  loans 
are  made  through  a  local  agent  which  must  be  a  bank,  trust  company, 
savings  bank,  or  mortgage  company  organized  in  the  state  in  which  the 
loan  is  made. 

2Sec.  7  of  t*>e  Act  gives  details  of  the  organization  of  these  asso- 
ciations. 


FARM  MORTGAGES  521 

The  restrictions  and  security  of  the  loans  of  these  national 
farm  associations  are  as  follows:  (1)  All  loans  shall  be  duly 
recorded  first  mortgages  on  property  located  within  the  dis- 
trict of  the  Federal  Land  Bank.  (2)  Repayment  of  the  loan 
must  be  made  on  an  amortization  plan,  and  this  plan,  according 
to  the  act,  must  conform  to  these  conditions ;  at  a  fixed  number 
of  annual  or  semi-annual  installments  sufficient  to  cover,  first,  a 
charge  on  the  loan,  at  a  rate  not  exceeding  the  interest  rate 
in  the  last  series  of  farm  loan  bonds  issued  by  the  land  bank 
making  the  loan ;  second,  a  charge  for  administration  and  profits 
at  a  rate  not  exceeding  one  per  cent  per  annum  on  the  unpaid 
principal,  said  two  rates  combined  constituting  the  interest  rate 
on  the  mortgage;  and  third,  such  amounts  to  be  applied  on  the 
principal  as  will  extinguish  the  debt  within  an  agreed  period 
not  less  than  five  years  or  more  than  forty  years.  The  whole 
of  the  loan  may  be  paid  at  any  time  after  five  years  upon  one 
of  the  installment  payment  dates.  (3)  Under  the  act,  no  loan 
on  a  mortgage  shall  be  made  with  interest  charges  in  excess  of 
6  per  cent  per  annum  exclusive  of  amortization  payments. 
(4)  The  loans  can  be  made  for  the  following  purposes:  (a)  to 
purchase  land  for  agricultural  purposes,  (b)  to  buy  equipment, 
fertilizers,  and  live  stock  necessary  for  the  operation  of  the 
mortgaged  farm,  (c)  to  provide  buildings,  (d)  to  liquidate  in- 
debtedness at  the  time  of  the  organization  of  the  first  National 
Association  and  for  the  purposes  described  under  topics  (a), 
(b),  (c).  (5)  Loans  shall  not  exceed  50  per  cent  of  the  values 
of  the  land  mortgaged  and  20  per  cent  of  the  improvements 
thereon.1  (6)  No  loans  can  be  made  excepting  to  farmers  who 
are  both  operators  and  owners  of  farms.  (7)  The  amount  of 
the  loans  must  not  be  less  than  $100  or  more  than  $10,000. 
(8)  The  general  regulations  laid  down  by  the  Board  shall  be 
complied  with.  (9)  A  rate  of  8  per  cent  shall  be  paid  on  any 


1PThe  limits  placed  throughout  the  Act  on  the  amount  which  can  be 
issued,  especially  by  the  Joint  Stock  Banks,  have  been  evaded  as  re- 
ported in  a  number  of  cases ;  for  example,  by  a  husband  deeding  a  por- 
tion of  the  land  to  his  wife  and  then  securing  two  loans.  While  this 
makes  no  difference  to  the  investor  who  holds  the  bonds  as  long  as  the 
margins  are  met,  there  is  no  denying  that  it  is  an  evasion  of  the  spirit 
of  the  law. 


522  INVESTMENT  ANALYSIS 

default  of  interest  or  principal.  As  dividends  are  to  be  paid,  if 
earned,  on  the  capital  stock  of  the  Federal  Land  Bank  owned 
by  the  National  Farm  Loan  Associations,  the  cost  to  the  bor- 
rower will  be  reduced  to  this  amount  on  his  loan.  The  earn- 
ing power  of  these  institutions  is  yet  to  be  proven,  and  as  a 
matter  of  fact  the  government  is  carrying  a  debt  of  millions  for 
these  organizations  because  of  the  failure  to  make  the  organi- 
zations pay  for  themselves. 

Sufficient  machinery  has  been  established  under  the  Act  to 
insure  careful  appraisals  of  land  values,  if  the  administration  of 
it  is  rigidly  carried  out.  According  to  the  Farm  Mortgage 
Bankers'  Association  of  America  appraisements  made  by  the 
banks  created  under  the  Act  have  often  been  loosely  made. 
When  a  loan  is  applied  for  through  the  National  Farm  Associa- 
tion, it  is  referred  to  the  loan  committee  of  three  members  who 
shall  make  a  detailed  report.  If  the  loan  is  then  approved  by 
the  National  Farm  Association  directorate,  the  application  and 
report  are  submitted  to  the  Federal  Land  Bank.  This  report  is 
then  referred  to  the  land  bank  appraiser  or  appraisers,  who  in 
turn  must  make  an  investigation  and  report  favorably  upon  the 
land  before  the  Federal  Land  Bank  board  can  grant  the  loan.1 
If  a  bond  issue  is  made  upon  the  mortgages  under  such  loans, 
the  appraisal  must  be  further  approved  by  the  Federal  Land 
Board.2 

The  farm  mortgages  which  are  taken  by  the  banks  to  secure 
t"ie  loans  advanced  can  be  used  by  the  banks  as  collateral  for 
lond  issues.  To  exercise  the  rights  of  this  privilege,  the  bank 


*See  Sections  7,  10,  12,  18,  19,  20  and  21. 

^Looseness  and  lack  of  administrative  control  are  to  be  expected  to 
some  degree  in  an  organization  as  large  as  has  been  undertaken  in  this 
enterprise.  This  is  especially  true  of  the  National  Farm  Loan  Associa- 
tions, many  of  which  have  never  been  carefully  reviewed  or  audited. 
"Unquestionably  strong  safeguards  and  checks  must  be  established  in 
protecting  against  loose  and  incapable  appraisers.  Some  of  the  cases 
cited  in  the  pamphlet  published  by  the  Farm  Mortgage  Bankers'  Asso- 
ciation on  "Loans  to  Speculators"  (second  edition,  Chicago  Office.  1920, 
p.  39)  are  rather  startling.  Yet  quite  apart  from  the  tax-exempt  fea- 
tures or  the  injustices  of  the  Act  raised,  the  investor  in  bonds  is  not 
endangered,  because  these  loans  are  the  exception  and  not  the  rule. 
Nevertheless  such  loans  are  not  excusable  and  detract  to  just  that  ex- 
tent from  the  value  of  the  security. 


FARM  MORTGAGES  523 

makes  a  written  application  to  the  farm  loan  registrar  of  the 
district  and  bonds  are  deposited  with  the  latter  to  the  amount 
required  to  secure  the  loan.  If  the  Federal  Farm  Loan  Board 
approves  the  granting  of  the  loan,  the  bank  can  then  proceed 
to  issue  the  bonds  on  the  security  of  the  mortgages  which  are 
deposited  with  the  registrar.1 

These  bonds  are:  (1)  issued  in  a  series  of  not  less  than 
$50,000;  (2)  to  be  coupon  bonds;  (3)  redeemable  at  the  option 
of  the  bank  after  five  years ;  (4)  to  be  in  denomination  from  $25 
to  $1,000;  (5)  if  not  retired  at  the  option  of  the  bank  after  five 
years  they  are  due  in  twenty  years;  (6)  to  be  issued  by  any 
bank  not  to  exceed  twenty  times  its  capital  stock  and  surplus; 
(7)  to  have  a  rate  of  interest  not  exceeding  5  per  cent.  In 
addition  to  the  liability  of  the  issuing  Federal  Land  Bank,  all 
the  other  Federal  Farm  Land  Banks  are  liable  for  the  pro  rata 
amount  of  their  share  of  the  bonds  outstanding  of  the  issuing 
bank,  if  the  issuing  bank  defaults. 

The  interest  and  amortization  payments  received  by  both 
the  Federal  Land  Banks  and  the  Joint  Stock  Banks  on  mort- 
gages held  as  collateral  security  for  the  issue  of  farm  loan  bonds 
shall  constitute  a  trust.  This  fund  is  to  be  used  by  Federal 
Land  Banks  for  the  purpose  of  (a)  paying  for  farm  loan  bonds; 
(b)  purchasing  farm  loan  bonds  below  par;  (c)  loaning  on  first 
mortgages  or  land  within  the  district  of  the  bank;  or  (d)  pur- 
chasing United  States  Government  bonds.  The  Joint  Stock 
Banks  have  the  same  privileges  except  that  in  (b)  they  can 
buy  farm  land  bonds  at  or  below  par. 

As  further  security  against  loans,  both  the  Farm  Loan  Asso- 
ciations and  Federal  Land  Bank  and  Joint  Stock  Banks  must 
accumulate  reserves  out  of  earnings.  This  is  to  be  accomplished 
in  National  Farm  Associations  by  setting  aside  not  less  than  10 
per  cent  each  year  out  of  current  earnings.  When  a  20  per 
cent  reserve  has  been  accumulated,  2  per  cent  of  earnings  shall 
be  annually  added.  When  the  reserve  is  impaired,  all  divi- 
dends shall  be  suspended  until  the  20  per  cent  has  again  been 
reached.  If  the  association  goes  into  voluntary  dissolution  the 


'See  Act,  Sections  18,  19,  20  and  21. 


524  INVESTMENT  ANALYSIS 

reserve  goes  to  the  Federal  Reserve  Banks.  The  Federal  Land 
Banks  and  the  Joint  Stock  Banks  must  also  accumulate  a 
reserve  up  to  20  per  cent  of  their  outstanding  capital.  An 
annual  amount  of  25  per  cent  of  the  earnings  shall  be  set  aside 
each  year  for  this  reserve  account  out  of  the  earnings  of  each 
year.  When  the  20  per  cent  requirement  has  been  reached  5  per 
cent  of  net  earnings  shall  be  annually  added  to  the  reserve.  In 
case  of  a  default  extending  over  a  period  of  two  years  in  prin- 
cipal and  interest  or  amortization  payments  on  mortgages,  this 
default  shall  be  deducted  from  the  reserve. 

The  Joint  Stock  Land  Banks  which  are  authorized  under 
the  same  statute  can  be  incorporated  by  ten  or  more  individuals. 
The  stock  of  these  banks  can  be  owned  by  individuals,  firms, 
or  corporations,  all  having  equal  voting  rights.  The  stock  of 
these  banks,  like  the  stock  of  the  Federal  Land  Banks,  carries 
with  it  a  double  liability.  A  minimum  of  $250,000  capital  stock 
must  be  subscribed  and  one-half  paid  before  the  bank  can  com- 
mence business. 

These  banks  have  the  right  to  advance  loans  on  first  mort- 
gages and  to  issue  farm  loan  bonds.  The  rules  governing  the 
issue  of  the  bonds  of  these  banks  are  generally  the  same  as  those 
of  the  Federal  Farm  Land  Banks,  except  that  the  issuing  bank 
alone  is  liable  for  its  own  bonds.  Interest  rates  on  mortgages 
are  subject  to  the  same  rules  as  those  of  the  Federal  Land 
Bank,  though  they  are  not  reviewed  by  the  Federal  Land  Board. 
Loans  are  restricted  as  to  amounts  or  purposes  to  which  funds 
are  put  by  the  farmer,  and  the  one  to  whom  the  loan  is  extended 
must  be  a  farmer.  Loans  are  confined  to  the  district  in  which 
the  bank  is  located  and  to  one  state  adjoining  this  district. 
The  total  amount  of  loans  is  limited  to  fifteen  times  the  amount 
of  the  capital  stock  and  surplus  of  the  bank. 

One  attractive  feature  to  the  large  purchaser  of  securities 
who  invests  in  the  bonds  issued  by  both  Federal  Farm  Land 
Banks  and  the  Joint  Stock  Banks  is  the  exemption  of  the  bonds 
from  any  taxation.  They  are  exempt  from  all  Federal  and  state 
taxes.  The  bonds  are  also  lawful  investments  for  all  judiciary 
and  trust  funds  and  may  be  accepted  as  security  for  all  public 
deposits.  Any  member  bank  of  the  Federal  Eeserve  System 


FARM  MORTGAGES  525 

and    Federal    Reserve   Bank   may   buy    and    sell    farm    loan 
bonds. 

The  Farm  Mortgage  Bankers'  Association  has  taken  a  deci- 
sive stand  against  the  injustice  of  the  tax-exempt  privileges, 
maintaining  that  this  feature  of  the  Act  should  be  amended. 
Without  question  this  will  sooner  or  later  follow.  As  already 
stated,  the  tendency  in  taxation  is  toward  the  elimination 
of  exemption.1  With  the  adoption  of  a  changeable  rate  on 
mortgages  and  a  non-tax  exemption  of  all  mortgages,  it  is  un- 
deniable that  the  Farm  Mortgage  Bankers  will  procure  what 
they  desire — an  equal  advantage  and  direct  competition.  One 
other  condition  maintained  by  the  Farm  Mortgage  Bankers 
beyond  all  contradiction  is  that,  if  additional  amendments  are 
needed  to  make  the  organization  pay  for  itself,  these  should  be 
made.  Unless  this  is  done,  American  tax  payers  at  large  must 
pay  for  the  support  of  the  industry  by  taxes. 


*E.  D.  Chassell,  Address  before  the  Illinois  Bankers  Association, 
La  Salle,  September  4,  1919.  (Secretary  Farm  Mortgage  Bankers  Asso- 
ciation of  America ;  Hearings  before  the  Committee  on  Banking  and 
Currency,  Sixty-sixth  Congress,  Second  Session,  January  10,  1920 ; 
Loans  to  Speculators  Ibid ;  E.  D.  Chassell  and  Kingman  Nott  Bobbins, 
The  Case  For  and  Against  Tax  Exemption  of  U.  S.  Government  Bonds 
and  Federal  Farm  Loan  Bonds  (Second  Edition,  Revised  1920,  p.  38.) 
See  also  Bulletins  of  Federal  Farm  Loan  Board,. 


CHAPTER  XXXI 
IRRIGATION  SECURITIES 

The  position  of  irrigation  securities1  has  changed  both  in 
character  and  distribution  in-  the  last  decade.  The  experi- 
ences of  the  purely  promotional  enterprises  under  the  Trow- 
bridge  and  Niver  leadership  in  Chicago  are  still  remembered 
by  some  investors  in  the  Middle  West  with  a  good  deal  of 
regret.  Though  the  majority  of  these  projects  were  fundamen- 
tally unsound,  their  failure  affected  the  whole  industry  and 
gave  sound  enterprises  an  unfortunate  setback.  A  careful  study 
of  the  matter,  however,  will  show  a  great  many  small  but  suc- 


1Although  Major  J.  Powell  of  the  Geological  Survey  of  the  United 
States  submitted  a  very  favorable  report  as  early  as  1S75  on  the 
irrigation  of  Western  lands,  nothing  of  much  consequence  was  under- 
taken until  the  Act  of  June,  1902,  though  the  original  Carey  Act  was 
passed  in  1894.  No  direct  bond  issues  are  made  under  the  first  named 
Act  by  the  government,  though  bonds  can  be  issued  by  private  corpora- 
tions on  land  coming  under  the  regulation  of  this  Act  and  also  under  the 
Carey  Act  which  will  be  described  later.  The  Irrigation  Act  of  1902 
does  not  enter  into  the  subject  of  irrigation  securities,  except  as  it  may 
indirectly  affect  them,  but  because  of  the  popular  misconception  that  it 
does,  it  is  well  to  state  briefly  the  character  of  the  Act. 

The  Act  provides  that  the  money  received  in  certain  states  from  the 
sale  of  land  (exceeding  the  5  per  cent  set  aside  for  education  purposes) 
shall  be  used  as  a  special  fund  for  the  construction  and  maintenance  of 
irrigation  works  for  reclaiming  semi-arid  land.  The  Secretary  of  the 
Interior,  when  he  has  selected  a  site  and  provided  for  the  building  of 
the  proper  irrigation  works,  allows  entries  of  a  given  size  to  be  made  on 
the  land  that  will  be  benefited  by  this  irrigation.  This  is  done  with  the 
provisions  that:  (1)  the  land  benefited  shall  pay  for  the  cost  of  con- 
structions; (2)  the  water  rights  and  the  land  shall  be  paid  for  in  ten 
equal  installments ;  (3)  the  water  rights  shall  be  sold  to  any  owner  of 
the  land,  but  not  in  excess  of  the  amount  needed  for  160  acres  of  land ; 
(4)  every  purchaser  of  water  rights  and  land  must  be  an  actual  settler 
on  the  land;  (5)  one-half  of  the  land  shall  be  cultivated;  (6)  when 
the  greater  part  of  the  land  shall  have  been  paid  for,  the  title  of  the 
ownership  of  all  the  irrigation  works  passes  into  the  hands  of  the 
settlers  who  will  then  control  them  under  a  form  of  organization  ac- 
ceptable to  the  Secretary  of  the  Interior.  The  Reclamation  Service  of 
the  United  States  has  irrigated  approximately  7  per  cent  of  all  irrigable 
land  in  the  United  States. 

620 


IRRIGATION  BONDS  527 

cessful  enterprises  which  were  developed  and  operated  even  dur- 
ing the  experimental  period  of  irrigation. 

While  these  early  failures  have  continued  to  influence  the 
Middle  West  and  Eastern  markets,  certain  irrigation  securities, 
through  constructive  development,  have  been  gradually  assum- 
ing a  fixed  but  limited  place  in  the  field  of  investments.  The 
distribution  of  these  securities,  however,  has  been  largely  con- 
fined to  the  states  originating  them,  principally  California, 
Oregon,  Washington,  Idaho,  and  Montana.  This  situation  no 
doubt  will  explain  the  reason  for  the  unfamiliarity  of  Eastern 
markets  with  these  securities. 

Contrary  to  the  popular  belief  that  the  majority  of  the  irri- 
gation projects  have  been  built  by  bond  issues — this  is  true  of  a 
comparatively  small  proportion.  Approximately  one-half  of 
the  projects,  excluding  those  controlled  by  the  government,  from 
the  first  irrigation  works  constructed  by  the  Mormon  immi- 
grants in  1847  in  Utah,  up  to  fifteen  years  ago  were  built  by 
individuals  and  partnerships.  The  greatest  difficulty  of  a  large 
part  of  the  irrigation  projects  in  the  United  States  has  been 
not  a  financial  one  but  the  technical  problem  of  irrigation 
itself.  But  relatively  small  in  number  as  the  projects  offering 
securities  to  the  public  may  seem,  they  nevertheless  are  of 
large  proportions  and  involve  millions  of  dollars.  Mr.  Herbert 
M.  Wilson  and  Mr.  John  A.  Widstoe  estimate  that  the  invest- 
ments in  irrigation  works  of  the  United  States  Government  ap- 
proximate $100,000,000.* 

Municipal  Irrigation  District  Bonds. — The  Irrigation  Dis- 
trict bonds  are  today  the  strongest  and  the  most  desirable  of 
all  irrigation  bonds.  As  a  matter  of  fact,  practically  all  irriga- 
tion projects  are  now  being  built  either  by  the  United  States 
Reclamation  Department  or  by  Municipal  Irrigation  Districts. 
Irrigation  district  bonds  are  issued  by  a  special  municipal  cor- 
poration tax  district.  As  explained  under  the  special  assess- 
ment bonds,  the  population  of  a  given  area,  desiring  to  procure 
funds  for  irrigating,  organizes  a  quasi-municipality  which  has 


aH.  M.  Wilson.  Irrigation  Engineering  (1912),  p.  2.  John  A.  Widstoe, 
Principles  of  Irrigation  Practices  (1914),  p.  462. 


528  INVESTMENT  ANALYSIS 

the  power  to  levy  taxes  within  this  given  area.  The  district 
issues  bonds,  the  interest  on  which,  together  with  the  principal, 
is  secured  by  a  prior  lien  upon  the  property  within  the  limits 
of  the  district. 

The  Irrigation  District  laws  of  the  state  of  Oregon  are  now 
(1920)  regarded  as  the  best  of  the  existing  state  irrigation  laws. 
Particular  care  has  been  given  in  the  framing  of  this  statute 
to  such  matters  as  the  creation  of  a  district  through  an  election 
by  the  citizens  of  the  district,  the  issuance  of  bonds,  the  con- 
firmation and  ratification  by  the  courts  of  the  legality  of  the 
issues,  the  certification  of  the  bonds,  the  guarantee  of  interest 
under  certain  conditions,  etc.  The  Oregon  statute  is  worthy 
of  much  more  detailed  consideration  than  this  chapter  allows. 
California,  Colorado,  Idaho,  Kansas,  Nevada,  and  Washington, 
the  states  possessing  the  older  works,  have  also  built  up  a  con- 
siderable body  of  laws  governing  these  municipal  irrigation  dis- 
tricts, which  also  have  been  copied  by  some  of  the  states  which 
have  undertaken  irrigation  projects  more  recently.  These  laws 
have  very  materially  strengthened  the  position  of  Municipal 
District  securities  in  these  states.  Practically  all  states  require 
that  bond  issues  shall  at  least  be  sanctioned  by  the  qualified  tax- 
payers of  the  district. 

Districts  like  the  Progressive,  New  Sweden  and  Snake  River 
in  Bonneville  County  and  the  Pioneer  and  Nampa  Meridian  in 
Ada  County,  Idaho,  are  comparable  in  production  capacity  to 
many  counties  in  the  Middle  "West.  Probably  one  of  the  best 
known  of  these  Municipal  Districts  is  the  Imperial  Valley  Dis- 
trict of  California.  Numerous  other  small  districts,  equally 
successful,  exist,  which  possess  rich  soil  and  have  large  produc- 
tive capacity.  The  sale  of  their  securities,  while  amply  pro- 
tected, is  confined  to  a  more  or  less  local  market. 

The  same  care,  however,  must  be  exercised  in  the  selection 
of  irrigation  securities  as  in  deciding  on  a  bond  of  any  other 
project.  Had  the  purchasers  of  the  bonds  of  certain  Municipal 
Districts  a  number  of  years  ago  familiarized  themselves  with  a 
few  of  the  fundamental  requirements  of  a  successful  irrigation 
project,  the  purchases  would  never  have  been  made.  For  exam- 
ple, in  one  district  in  Colorado,  which  had  both  ample  water 


IRRIGATION  BONDS  529 

supply  and  fertile  soil,  and  had  demonstrated  its  productive 
capacity — it  was  found  that  the  district  was  too  far  removed 
from  transportation  to  make  it  a  paying  proposition.  In  fair- 
ness, however,  it  should  be  said  that  from  the  start  this  was  a 
promotional  enterprise.  Had  the  purchasers  of  these  securities 
obtained  some  information  as  to  the  length  of  time  this  land 
had  been  occupied  and  owned  by  settlers  as  well  as  the  method 
of  selling  it — they  would  never  have  bought  these  bonds  as 
investments. 

Carey  Act  -Bonds. — While  the  Carey  Act  Bonds  at  this  time 
are  relegated  to  the  background,  the  early  experiences  with 
these  issues  are  instructive  to  the  beginner.  Offerings,  however, 
made  by  private  land  or  development  companies  operating 
under  the  Carey  Act,  occasionally  do  appear. 

In  order  to  hasten  the  settlement  of  arid  and  unoccupied 
land  the  Carey  Act  (since  amended)  was  passed  in  1894.1  By 
this  act  the  Federal  government  can  give  to  the  various  arid 
states  unappropriated  lands  within  their  respective  borders 
under  the  condition  that  the  land  be  sold  to  actual  settlers. 
Ten  states  have  passed  legislation  appropriate  to  the  require- 
ments of  the  Act,  though  actual  reclamation  has  taken  place  in 
only  five  states.3  These  tracts  are  to  be  sold  in  plots  not  to 
exceed  one  hundred  and  sixty  acres  to  one  person,  and  at 
least  twenty  acres  must  be  irrigated  and  put  under  cultivation 
in  each  plot.  The  primary  purpose  of  the  Act  was  to  assist  the 
states  in  the  settlement  of  these  unoccupied  lands  and  at  the 
same  time  to  protect  the  settlers  and  the  United  States  from 
fraud. 


'Carey  Act  originally  passed  August  18,  1894,  28  Stat,  422.  Import- 
ant Amendments:  Act  June  11,  1896;  29  Stat.  434.  Act  of  March  3, 
1901 ;  31  Stat.,  1188. 

2The  amount  of  these  five  states  projected  and  irrigated  in  1917  was 
as  follows : 

Area  Projected     Area  Irrigated  1917      Per  Cent 
State  in  Acres  in  Acres  Reclaimed 

Idaho    868,300  456,600  52.5 

Y/yoming    250,400  114,150  41.5 

Montana 183,000  82,000  44.6 

Oregon    82,000  25,000  30.4 

Colorado     1,405,700  692.750  49.3 

Guy  Ervin  Irrigation  under  Provisions  of  Carey  Act,  U.  8.  Depart- 
ment of  Agriculture  (Circular  124),  p.  6  (February,  1919). 


530  INVESTMENT  ANALYSIS 

"With  the  passage  of  this  Act  private  capital  quickly  organ- 
ized to  avail  itself  of  the  privileges  granted  under  the  Act. 
After  the  application  has  been  approved  by  the  State  Engineer, 
the  State  Board  of  Land  Commissioners,  the  Secretary  of  the 
Interior,  and  the  President,  the  corporation  can  reclaim  the 
assigned  lands  and  appropriate  water  rights  in  the  adjacent 
state  streams  under  the  supervision  of  the  state.  The  Federal 
government  agrees  to  give  the  corporation  a  first  lien  on  all 
these  rights  and  not  to  sell  the  land  until  the  settler  has  se- 
cured from  the  corporation  corresponding  perpetual  water 
rights  for  his  lands.  The  purchase  of  these  water  rights  by 
the  individual  from  the  corporation  is  made  possible  under 
"The  Carey  Act  contract"  which  forms  the  real  security  of  the 
"Carey  Act  Bonds."  The  cost  to  the  settler  is  generally  from 
twenty-five  to  forty  dollars  an  acre,  though  often  higher.  Ten 
per  cent  is  required  in  cash  payment  and  promissory  notes  are 
given  for  the  remainder,  but  the  title  does  not  pass  from  the 
state  to  the  settler  until  the  actual  settlement  of  the  land  has 
been  made  and  it  is  under  cultivation.  In  Idaho,  the  title 
cannot  be  given  until  two  years  after  the  irrigation  project  is 
completed.  As  some  time  must  elapse  after  these  bonds  are  first 
issued  on  new  projects,  before  they  have  any  security  of  conse- 
quence back  of  them,  and  as  the  construction  company  never 
has  any  title  to  the  land,  the  security  rests  in  the  future  com- 
pletion of  the  irrigation  works.  The  so-called  "first  lien  on 
lands"  and  "water  rights"  at  the  time  of  the  sale  of  these 
bonds  are  then  merely  future  possibilities  depending  upon  the 
success  of  both  the  irrigation  works  and  the  cultivation  of  the 
land. 

Private  Corporation  Bonds. — Practically  all  private  enter- 
prises can  be  placed  in  one  of  two  general  classes.  The  one 
includes  corporations  which  control  only  their  water  system  and 
canals.  The  bonds  of  these  companies  are  probably  the  weakest 
of  the  irrigation  securities.  In  the  other  class  are  included  the 
corporations  whose  bonds  are  secured  by  both  water-rights  and 
land. 

With  both  of  these  types  of  companies  the  payment  of  their 
bonds  depends  on  how  efficiently  they  transport  their  water. 


IRRIGATION  BONDS  531 

This  condition  virtually  makes  these  corporations  common  car- 
riers and  consequently  more  subject  at  the  present,  at  least,  to 
restrictive  legislation.  Companies  of  this  character,  as  for 
example  in  Colorado,  have  been  known  to  suffer  considerably 
from  such  legislation.  Where  the  possessor  of  these  securities 
has  attempted  to  foreclose,  he  has  usually  experienced  consid- 
erable difficulty  in  establishing  his  rights  at  equity  over  those  of 
the  owner  of  the  land. 

In  the  second  form  of  corporate  enterprise,  the  bonds  are  a 
lien  on  all  the  property  owned  by  the  company.  The  payment 
of  these  bonds  depends  on  the  sale  of  the  land  to  settlers.  If 
conditions  are  unfavorable  for  the  sale,  it  generally  means  that 
the  bonds  automatically  become  defunct.  The  ordinary  practice 
in  a  project  of  this  type  is  to  organize  two  companies,  namely, 
a  land  company  and  a  water  company.  The  land  company  will 
mortgage  each  tract  of  land  to  the  water  company  (this  mort- 
gage is  assumed  by  the  individual  settler)  for  the  accompanying 
water-right  of  that  tract.  The  water  company  then  bonds  its 
properties  and  deposits  these  bonds  with  a  trust  company  as 
collateral  security  for  the  bondholders. 

Security  of  Irrigation  Bonds. — The  more  important  tests 
which  should  be  applied  to  any  of  the  irrigation  projects  in 
determining  their  value  are  as  follows:  (1)  location  of  the 
project;  (2)  accessibility  to  transportation;  (3)  amount  and 
permanency  of  the  water  supply;1  (4)  percentage  of  lands  of 
the  irrigated  area  under  cultivation;  (5)  percentage  of  waste 
land;  (6)  population  of  the  irrigated  area;  (7)  lien  per  acre;1 
(8)  annual  average  crop  yields;  (9)  assessed  valuation  of  the 
district8;  (10)  land  titles  and  associated  water-rights;  (11) 
the  cost  of  the  project;  (12)  the  capitalization  of  private  irri- 
gation enterprises;  (13)  capital  possessed  by  settlers  on  new 
areas  being  developed;  and  (14)  the  use  to  which  the  bond  pro- 
ceeds are  to  be  put,  whether  for  the  construction  of  new  devel- 

^See  chap,  xxii  on  Hydro-Electric  Securities,  Topics  on  Water  Supply, 
Pondage  and  Control. 

2See  chap,  xxxii  on  Drainage  and  Levee  Bonds  and  Farm  Mortgages 
on  the  topics  of  security  and  liens. 

3See  chap,  xxxiv  on  Valuation,  Tax  Bate  nd  Validity  as  Related  to 
Civil  Loans. 


532  INVESTMENT  ANALYSIS 

opment  or  toward  the  purchase  of  a  project  which  has  been  in 
operation  for  several  years.1 

As  a  number  of  these  features  have  already  been  demon- 
strated, it  does  not  seem  necessary  to  discuss  in  complete  detail 
the  several  tests  that  distinguish  a  good  from  a  bad  irrigation 
bond.  Certain  conditions  which  are  peculiar  to  this  industry 
are,  however,  in  need  of  further  consideration. 

Water  Supply.1 — The  larger  part  of  the  failures  in  irrigation 
projects  in  recent  years  due  to  lack  of  water  supply  recall  the 
early  contentions  of  a  number  of  prominent  and  conservative 
irrigation  engineers.  They  consistently  maintained  that  a  lack 
of  water  supply  would  be  one  of  the  serious  difficulties  resulting 
from  the  abnormal  growth  of  irrigation  projects.  In  arid 
regions,  at  least,  the  success  or  failure  of  the  project  largely 
depends  upon  the  available  water  supply.  And  as  the  security 
of  all  irrigation  bonds  depends  directly  on  the  success  of  the 
irrigation  works,  and  the  irrigation  works  are  of  no  avail  with- 
out a  sufficient  water  supply,  the  first  requisite  in  a  considera- 
tion of  irrigation  securities  is  the  water  supply. 

In  this  respect  large  government  projects  of  the  future  will 
have  the  advantage  over  the  smaller  projects,  and  as  pointed 
out  elsewhere,  the  large  costs  involved  in  securing  water  will 
be  the  factor  limiting  the  number  of  new  irrigation  projects 
outside  of  the  Federal  government  institutions.  Not  only  is  it 
becoming  more  costly  in  many  cases  to  obtain  water  because  of 
the  remoteness  of  a  sufficient  supply  but  also  the  enormous 
expense  involved  in  obtaining  a  guarantee  of  an  adequate  sup- 
ply of  water  will  make  it  increasingly  difficult  to  induce  capital 
to  invest  in  private  projects. 

Great  credit  must  be  given  the  majority  of  the  engineers  for 
their  careful  supervision  of  the  construction  of  irrigation  works. 
Much  of  this  construction,  however,  has  been  of  an  entirely  new 
character,  often  giving  rise  to  problems  which  could  not  possi- 
bly be  foreseen  and  hence  are  more  difficult  to  handle.  For  exam- 
ple, the  character  of  run-offs,  the  variation  in  evaporation,  the 

*See  chap,  xxxiv  on  Valuation,  Tax  Rate  and  Validity  as  Related  to 
Civil  Loans. 

Chap.  XXII. 


IRRIGATION  BONDS  533 

influence  of  soils  on  seepage,  the  effect  of  water  sheds,  the  losses 
from  waste,  and  the  character  of  the  source  of  the  supply  of 
water,  are  just  beginning,  with  the  increased  amount  of  data  on 
these  subjects,  to  be  ascertained.1  Under  the  older  and  smaller 
projects,  these  difficulties  were  never  experienced,  but  the  esti- 
mates made  for  a  number  of  the  newer  systems  upon  the  basis 
of  these  older  projects  led  to  a  number  of  unhappy  results, 
because  the  newer  systems  did  not  have  the  cheap  and  abundant 
supply  of  water  possessed  by  the  old  projects. 

Land  Title. — Land  titles2  can  hardly  be  considered  apart 
from  their  associated  water  rights.  Private  projects,  however, 
from  the  standpoint  of  the  investor  cannot  be  commended  unless 
the  land  title  is  separately  guaranteed.  "Where  the  bonds  of 
private  corporations  are  secured  both  by  the  water  rights  and 
the  guaranteed  land  title,  other  things  being  equal,  they  are 
preferable  to  the  Carey  Act  bonds.  Even  in  an  area  which  has 
a  partial  rainfall,  the  mortgage  on  the  land,  even  if  the  irriga- 
tion project  fails  or  is  not  completed,  has  some  value. 

As  the  municipal  district  bonds  are  issued  by  the  districts, 
the  land  title  is  not  a  direct  issue,  though  indirectly  it  may 
become  all-important.  If  the  greater  part  of  the  land  of  a 
municipal  district  is  open  only  to  homesteading  and  is  not  yet 
occupied,  it  is  not  subject  to  taxation.  Regardless,  then,  of 
how  large  the  area  occupied  may  be,  an  impossible  burden 
may  be  placed  upon  the  small  part  of  the  area  occupied.  But 
this  is  a  problem  of  occupancy  rather  than  one  of  land  title, 
as  occupancy  automatically  determines  both  ownership  and  the 
ability  of  the  district  to  meet  the  bond  obligation. 

Land  titles  can  hardly  be  considered  an  issue  with  the  Carey 
Act  bonds.8  As  the  ownership  passes  directly  from  the  Federal 


Samuel  Fortier,  Use  of  Water  in  Irrigation,  pp.  13-18.  Frederick  H. 
Newell  and  Daniel  W.  Murphy,  Principles  of  Irrigation  Engineering, 
pp.  263-275.  Herbert  M.  Wilson,  Irrigation  Engineering,  pp.  7-34. 

2Herbert  M.  Wilson,  Ibid.;  J.  A.  Widstoe,  pp.  371-373. 

*As  it  is  impossible  under  the  Carey  Act  for  an  irrigation  company 
ever  to  acquire  even  one  acre  of  land,  the  assertion  widely  advertised  a 
few  years  ago  by  many  organizations  selling  these  securities,  that  these 
lands  constitute  a  direct  lien  on  the  irrigated  property,  was  not  true 
at  the  time  of  the  sale.  This  "lien"  can  be  made  only  against  the  settler 
himself  and  his  water  rights.  It  was  one  of  the  chief  purposes  of  the 


534  INVESTMENT  ANALYSIS 

government  through  the  state  to  the  purchaser,  the  title  to  the 
land  is  assured  when  the  water  right  fees  and  the  small  home- 
stead charges  have  been  paid,  and  the  initial  cultivation  require- 
ments have  been  fulfilled.  Again,  of  course,  water  rights  and 
the  completion  of  the  irrigation  works  determine  the  value  of 
the  land  which  secures  the  bond  issue. 

Costs. — With  the  failures  beginning  in  1908,  the  charge  was 
brought  of  great  extravagance  in  the  construction  of  irrigation 
works.  This  has  been  especially  true  of  the  Federal  government 
projects  which  do  not  come  under  our  consideration.  While 
this  charge  has  been  justifiable  in  some  cases,  many  critics  fail 
to  realize  that  the  enhanced  difficulty  of  building  these  projects 
brings  with  it  an  increased  cost  in  construction.  The  early 
projects  had  soon  utilized  the  accessible  and  easily  irrigated 
lands  in  the  arid  regions,  and  with  each  added  project,  it  has 
been  necessary  to  build  more  costly  works  in  order  to  insure 
an  adequate  water  supply.  To  the  investor,  this  is  of  import- 
ance, as  the  cost  of  construction  determines  the  ratio  of  capi- 
talization per  acre  of  irrigated  area,  which  is  comparable  to  the 
mileage  measurement  on  railroads.  But  here  again,  is  an  illus- 
tration in  comparative  statistics  which  the  student  must  use 
within  its  limitations. 

The  range  of  these  costs  seems  to  the  average  layman  almost 
inconsistent  with  sound  business,  until  the  specific  causes  have 
been  determined.  At  Grand  Junction,  Colorado,  where  there 
are  five  district  enterprises  pumping  water  to  their  land,  the 
costs  at  the  time  of  construction  ranged  as  follows: 


Carey  Act  to  prevent  land  grabbing;  otherwise,  it  would  have  been  an 
easy  matter  for  a  company  to  place  dummies  on  the  various  tracts  and 
obtain  enormous  areas  of  valuable  land.  The  widespread  idea  that  the 
bonds  are  secured  "by  a  deposit  with  the  trustee  of  the  settler's  mort- 
gages" is  still  further  weakened  by  the  lack  of  any  title  to  the  land 
on  the  part  of  the  settler  himself,  till  after  the  government  patent  has 
been  granted.  This  patent,  as  will  be  recalled,  cannot  be  given  in  some 
states  till  after  a  certain  term  of  actual  settlement.  But  even  if  the 
settler  is  allowed  to  take  the  direct  title  to  this  land,  as  he  is  permitted 
to  do  in  a  few  states,  the  Carey  Act  still  makes  the  mortgage,  if  con- 
tracted, non-enforcible.  In  addition  to  this,  the  companies  of  more 
doubtful  standing  are  compelled  to  issue  the  greater  part  of  their  bonds 
before  any  construction  is  really  begun.  What  security  is  offered  to 
these  bondholders?  Nothing  but  the  goodwill  of  the  corporate  enter- 
prise; consequently,  the  mortgage  feature  of  the  bonds  is  chiefly  fic- 
titious. 


IRRIGATION  BONDS  535 

Debts  Cost  per  Aero 

Palisade $205,800  $45.00 

Mesa   205,000  78.00 

East  Palisade   '53,600  89.00 

Orchard  Mesa  1,329,480  153.00 

S.  Palisade  Heights 110,600  180.00 

In  Yakima  Valley  water  rights  of  private  projects  vary  from 
$50  to  $135  and  over.  Eight  private  projects  in  Colorado  ex- 
ceed $60  per  acre  and  two  over  $100.  In  Idaho,  the  Carey  Act 
projects  vary  from  $25  to  $65  per  acre.1  These  illustrations  are 
sufficient  to  indicate  the  variation  in  debt  burden  that  these 
irrigation  works  carry.  If  a  bonded  obligation  of  $30  per 
acre  were  assumed  to  build  a  project,  the  burden  would  not 
become  so  great  if  $20  per  acre  had  to  be  added  to  complete 
the  work,  or  the  water  supply  was  found  to  be  insufficient.  But 
to  add  $20  to  an  acreage  already  carrying  $180  indebtedness,  is 
a  different  proposition.  And  not  infrequently,  where  the  topog- 
raphy of  the  country  makes  the  cost  of  erecting  the  works  high, 
the  farmer  for  the  same  reason  finds  it  costly  to  put  his  farm  in 
a  condition  making  irrigation  possible. 

As  the  settler  must  ultimately  pay  the  obligation,  this 
decreases  the  possibility  of  security,  especially  if  the  settler 
depends,  as  the  majority  do,  on  his  crops  for  providing  both 
working  capital  and  future  payments  of  his  obligations. 

Where  the  region  allows  of  an  irrigation  project  being  easily 
developed  and  three  or  four  crops  can  be  matured  in  a  year,  its 
acreage  can  obviously  carry  a  much  greater  construction  cost 
than  an  irrigated  area  located  in  the  more  northerly  climates 
where  only  one  crop  is  possible,  Adaptability  of  soils  to  a  wide 
range  of  varied  crops  under  the  same  geographical  conditions, 
will  also  permit  the  same  relative  increases  in  costs.  Specifically 
what  these  variations  will  be,  cannot  yet  be  foretold,  as  the  pro- 
jects are  too  new  to  have  allowed  the  acquiring  of  adequate  data. 
But  a  correct  analysis  of  these  influences  upon  costs  must  de- 
termine the  amount  of  warranted  funded  debt  that  should  be 
assumed. 


*D.  C.  Henry,  Engineering  News,  vol.  Ixxvi,  January  15,  1914, 
pp.  120-4.  These  costs  have  since  greatly  increased  on  most  irrigation 
works. 


536  INVESTMENT  ANALYSIS 

Capitalization  of  Private  Enterprises. — One  type  of  private 
enterprise  has  often  floated  a  bond  issue  at  the  rate  of  one  and 
one-half  of  the  value  of  possible  future  water  rights,  to  one 
of  the  bonds,  whose  only  security  are  those  same  water  rights  of 
the  future.  It  must  always  be  borne  in  mind  that  this  secu- 
rity is  not  tangible  till  the  works  are  completed.  If  the  proper 
estimates  have  been  made  so  that  the  work  can  be  carried  to 
completion,  it  may  prove  a  safe  investment,  but  at  the  time  of 
the  bond  sale  it  cannot  be  considered  other  than  the  highest 
type  of  speculation.  As  already  stated,  if  the  land  is  in  a  semi- 
arid  region,  the  land  itself  will  have  some  value  if  the  bond 
has  been  made  a  first  mortgage  upon  the  land.  The  danger  here 
usually  lies  in  the  valuing  of  the  land  not  as  semi-arid  land, 
but  as  irrigated  land. 

The  second  type  of  private  corporation  which  offers  the 
security  of  both  land  and  the  accompanying  water-rights  has  the 
same  objectionable  features.  If  the  corporation  is  an  entirely 
new  enterprise  in  an  arid  region,  the  land  is  generally  utterly 
worthless  till  water  is  available.  The  real  success  of  the  con- 
cern depends  upon  the  ability  of  its  promoters  as  agents,  for 
the  whole  income  of  the  company  must  come  from  this  source. 
Corporations  of  this  type  need  to  be  closely  scrutinized  by  the 
investor. 

The  lack  of  a  legitimate  amount  of  capital  stock  in  propor- 
tion to  the  issue  of  bonds,  also,  shifts  to  the  bondholders  a  great 
part  of  the  risks  which  in  any  new  conservative  undertaking 
should  belong  to  the  stockholders.  Neither  the  state  nor  Fed- 
eral government  makes  any  regulation  as  to  the  amount  of  capi- 
tal stock  corporations  should  issue.  A  risk  such  as  this  is  ex- 
actly what  a  careful  investor  in  bonds  desires  to  avoid,  for  the 
irrigation  works  and  the  land  of  an  enterprise  that  has  failed 
have  little  value. 

As  already  stated,  district  irrigation  bonds  are  the  best  of 
the  irrigation  securities,  if  the  irrigation  project  is  completed 
within  the  proposed  period.  If,  however,  the  project  is  not  thus 
completed,  the  settlers,  if  wholly  dependent  upon  this  water 
supply  to  cultivate  the  land,  are  probably  unable  to  meet  the 
tax.  The  only  security  back  of  these  bonds  then  may  be 


IRRIGATION  BONDS  537 

worthless  land.  In  addition  to  this,  as  is  often  the  case,  a  large 
part  of  the  area  may  be  government  land,  which  is  not  subject 
to  tax  until  homesteaded.  This,  of  course,  lessens  the  worth  of 
the  security,  as  the  entire  burden  is  placed  upon  the  remaining 
land  of  the  district  benefitted,  and  this  is  especially  burdensome 
where  the  population  is  small.  The  irrigation  district  under 
the  Wright  Act  experienced  this  very  difficulty.  The  cost  of 
the  irrigation  was  so  great  and  the  districts  were  so  slowly  set- 
tled, that  the  bonded  debt  was  more  than  the  population  could 
meet  by  taxation.  Unable  to  obtain  legal  relief  they  either 
repudiated  their  bonds  or  reduced  the  principal  and  interest.  It 
is  quite  evident,  then,  that  the  payment  of  these  bonds  does  not 
depend  on  their  original  value  or  present  earning  capacity,  but 
on  the  future  completion  of  the  project.  Where  the  district 
has  been  settled  for  some  time,  the  bonds  may  be  issued  to 
extend  an  existing  system.  If  the  land  in  the  district  has  not 
been  already  heavily  mortgaged,  these  bonds  may  have  sufficient 
security  to  place  them  in  the  highest  class  of  conservative 
investments. 

Working  Capital  Requirements  for  Settlers. — Lack  of  work- 
ing capital  by  the  settler  has  been  one  of  the  serious  difficulties 
connected  with  the  operation  of  the  irrigation  system.  Often 
failure  has  not  been  directly  due  to  the  irrigation  organization, 
but  to  the  ignorance  of  the  settler  concerning  the  technical  prob- 
lems involved  in  irrigated  land.  The  successful  farmer  of  the 
Middle  West  has  often  been  as  much  of  a  failure  with  irrigated 
land  as  the  novice  at  farming.  The  settler  has  usually  used 
all  his  available  capital  in  making  the  initial  payment  and  made 
no  provision  for  getting  his  farm  ready  for  irrigation.  He  esti- 
mates that  he  will  be  able  to  meet  his  subsequent  payments 
from  the  proceeds  of  his  crops.  But  irrigating  is  of  little  value 
unless  the  land  has  been  properly  leveled  up  so  that  irrigating 
ditches  may  benefit  equally  all  portions  of  the  area.  Rarely 
except  in  a  river  valley  is  a  farm  found,  so  located  that  it  does 
not  involve  a  considerable  expense  in  placing  it  in  proper  con- 
dition for  irrigation.  Then  also,  certain  soils  need  fertilizer 
to  contribute  the  chemicals  necessary  for  the  crops  best 
adapted  to  a  particular  locality.  While  it  is  true  that  this 


538  INVESTMENT  ANALYSIS 

is  a  technical  problem  in  irrigation,  the  failure  of  the  farmer 
to  recognize  it  may  spell  disaster  for  him,  and  consequently 
affect  the  status  of  the  whole  project.  The  same  thing  has 
been  true  and  even  more  so  where  there  has  been  a  complete 
destruction  of  crops  by  either  frosts  or  storms.  One  authority 
states  that  80  per  cent  of  the  settlers  on  newly  irrigated  land 
have  no  knowledge  of  irrigation  problems. 

The  Market. — The  market  for  irrigation  securities  has  never 
been  wide.  As  stated  in  the  introduction  to  this  chapter  the 
chief  market  for  these  securities  is  found  in  the  state  and  the 
adjoining  states  in  which  the  irrigation  project  is  originated. 
And  while  the  market  is  local  to  the  Northwest  and  Pacific  Coast 
states,  some  of  the  issues  are  fairly  active.  No  market  except 
now  and  then  for  a  larger  issue  exists  east  of  the  Missouri  River. 

One  authority  states  that  there  are  at  least  one  hundred  suc- 
cessful municipal  irrigation  districts  whose  bonds  have  a  fairly 
free  market  in  line  with  other  securities  in  the  Northwest  and 
Far  Western  states.  The  municipal  issues  also  have  the  advan- 
tage of  being  tax  exempt,  and  are  legal  investments  for  the 
majority  of  this  same  group  of  states. 


CHAPTEE  XXXII 
DRAINAGE  AND  LEVEE  BONDS 

Drainage  and  levee  bonds,  like  irrigation  bonds,  are  reclama- 
tion issues  depending  for  their  success  upon  the  proper  solution 
of  both  land  and  water  problems.  Though  drainage  issues  and 
levee  issues  are  made  for  entirely  opposite  purposes — the  for- 
mer to  eliminate  surplus  water,  the  latter  to  prevent  overflow — 
their  problems  as  to  land  tenure  and  the  securing  of  funds  for 
developing  the  project  are  quite  similar.  Drainage  and  levee 
bonds  can  be  classified  as  either  private  corporation  bonds  or 
special  assessment  district  bonds.  In  this  discussion  they  are 
put  in  the  former  classification.  The  limited  experience  with 
both  drainage  and  levee  districts  necessitates  a  closer  analysis 
of  the  physical  security  of  these  bonds  than  of  the  equity  of 
other  special  assessment  securities.  As  to  their  legality,  assess- 
ments, valuation,  population,  and  taxation,  these  securities  can 
be  analyzed  as  are  other  special  assessment  securities.1 

"Where  special  drainage  or  levee  districts  are  organized 
within  the  boundaries  of  a  city  or  town,  drainage  and  levee 
bonds  may  well  be  considered  as  special  assessment  bonds. 
Bonds  issued  by  districts  organized  in  well  established  farming 
areas  for  the  purpose  of  constructing  ditches  and  drains,  though 
subject  to  special  statutes,  can  also  be  treated  as  any  other 
improvement  bonds.  The  same  can  be  said  of  the  bonds  of  spe- 
cial sanitary  districts — created  by  general  or  special  enactments 
— which  include  a  city,  as  for  example  the  Sanitary  District  of 
Chicago.  However,  issues  of  districts  created  for  the  purpose 
of  reclaiming  new  land  for  agricultural  use  should  be  given 
more  careful  attention,  as  these  present  special  and  peculiar 
problems  quite  distinct  from  those  affecting  the  creation  of  tax 


*See  chaps,  xxxiv  and  xxxv 

539 


540  INVESTMENT  ANALYSIS 

districts  for  other  purposes.  And  the  emphasis  in  this  chapter 
is  placed  upon  the  problems  of  these  agricultural  districts.1 

Levee  and  "agricultural  drainage  bonds"  have  only  in 
recent  years  come  to  general  public  notice,  though  they  have 
been  offered  in  local  markets  for  twenty  years  or  more.  The 
earliest  efforts  at  constructing  drainage  and  levee  systems  were 
conducted  by  individuals,  and  were  handled  through  personal 
credit.  These  earlier  projects  used  the  small  areas  from  which 
it  was  possible  to  drain  water,  but  as  it  became  necessary  to 
use  larger  areas  to  get  the  desired  drainage,  the  size  of  the  dis- 
trict had  to  be  increased  correspondingly  and  so  individual 
undertakings  developed  into  cooperative  organizations.  These 
projects  in  turn  continued  to  increase  in  size  in  order  to  obtain 
sufficient  funds  to  assure  effective  physical  drainage.  To  effect 
this  financing,  so  called  districts  were  created  and  organized 
into  civil  corporations  in  order  to  obtain  funds  from  the  out- 
side. The  bond  issues  of  the  first  projects  growing  out  of  these 
early  undertakings  were  limited  to  less  than  $100,000.  As  the 
size  of  the  earlier  issues  made  it  possible  for  the  local  investors, 
who  have  been  eager  buyers  of  these  securities,  to  purchase  the 
greater  part  of  the  offerings,  only  a  few  of  these  issues  came  to 
public  notice.  This  condition  has  consequently  prevented  the 
larger  investment  market  from  becoming  familiar  with  these 
securities.  The  fact  that  the  Federal  government  has  built 
some  of  the  large  levee  projects  has  also  tended  to  eliminate 
the  necessity  for  large  expenditures  by  private  corporations  for 
levee  purposes.  The  states  of  Arkansas,  Louisiana,  California, 
Illinois  and  Ohio  have  made  the  largest  expenditures  for  levees, 
though  their  appropriations  for  this  purpose  have  only  equalled 
one-fifth  to  one-third  of  their  appropriations  for  drainage. 

The  growth  of  drainage  expenditures  is  well  illustrated  in 
Missouri.  The  outlay  by  drainage  districts  in  that  state  in  1915 
amounted  to  $10,000,000  as  compared  to  less  than  $1,000,000 
in  1900.  But  the  expenditures  for  drainage  to  reclaim  agricul- 
tural lands  have  been  confined  almost  wholly  to  the  Mississippi 


*See  chapters  on  Civil  Loans.  See  also  R.  S.  Hecht,  Louisiana 
Municipal  Drainage  Bonds  Convention  of  the  Investment  Banker's  Asso- 
ciation of  New  York  (1912)  Proceedings,  pp.  172-180. 


DRAINAGE  AND  LEVEE  541 

and  Ohio  Valley  states,  and  the  state  of  California.  The  salt 
marshes  of  the  Atlantic  and  Gulf  states  have  scarcely  been 
touched.  With  the  growing  congestion  of  an  increasing  popu- 
lation even  larger  areas  will  be  reclaimed  and  the  output  of 
these  securities  added  to  materially.  For  the  immediate  future, 
however,  the  larger  output  of  agricultural  drainage  bonds  will 
be  in  the  Mississippi  Valley  states.  It  is  claimed  by  one  author- 
ity that  in  the  Mississippi  Valley  alone  there  are  25,000,000 
acres  of  land  awaiting  drainage  and  improvements.1 

Organization  of  Districts. — In  some  few  cases,  a  city  will 
assume  a  drainage  or  levee  issue  as  a  direct  obligation.  The 
majority  are,  however,  issued  by  the  civil  division  of  the  county 
or  by  a  specially  created  district.  "Where  the  issue  is  secured 
by  a  large  area  covering  several  counties,  the  issue  must  neces- 
sarily be  made  by  a  district.  The  total  amount  of  the  outstand- 
ing issues  of  the  districts  approximately  equals  the  total  sum 
issued  by  counties,  though  the  issues  of  the  latter  are  for  the 
smaller  drainage  areas. 

When  a  given  number  of  land  owners  of  a  proposed  area, 
representing  a  stated  proportion  of  the  land  of  this  area,  desire 
to  construct  ditches  for  drainage,  or  levees  for  protection  against 
overflow,  a  properly  attested  petition  requesting  the  organiza- 
tion of  a  district2  is  generally  prepared  and  filed  in  the  juris- 
dictional  court.  This  petition  stipulates  in  detail  the  owner- 


irrom  K.  Smith,  address  on  Drainage  Bonds  delivered  before  the 
Investment  Bankers'  Association,  September  21,  1915,  Denver,  Colorado 
(Proceedings,  pp.  129-130). 

J.  Sheppard  Smith  further  states  :  "In  the  state  of  Louisiana,  alone, 
there  are  said  to  be  10,196,605  acres  of  swamp  or  marsh  lands  which 
should  be  drained  wholly  or  in  part ;  in  Arkansas,  5,912,300  acres ;  in 
Mississippi,  5.760,200  acres ;  in  Missouri.  2.439,600  acres,  and  in  Alabama, 
1,479,200  acres  (Annals  of  American  Academy  of  Political  and  Social 
Science,  vol.  Ixxxviii,  March,  1920,  p.  103). 

2No  attempt  is  made  in  this  discussion  to  give  an  exhaustive  state- 
ment of  the  different  methods  of  organization.  In  the  state  of  Missouri 
these  articles  are  filed  with  the  clerk  of  the  circuit  court.  The  juris- 
diction court,  of  course,  is  not  the  same  in  all  states.  If  the  drainage 
area  is  in  more  than  one  county,  the  articles  are  presented  to  the  court 
in  the  county  in  which  most  of  the  land  is  situated.  This  act  is  known 
as  the  Circuit  Court  Drainage  Act  (passed  in  1913).  It  has  been 
largely  copied  by  several  states. 

The  compilation  of  the  Drainage  Laws  of  the  various  states  by  the 
Investment  Bankers'  Association  is  a  useful  compendium  to  any  one  in- 
terested in  these  securities. 


542  INVESTMENT  ANALYSIS 

ship,  area  and  character  of  drainage,  other  lands  affected,  and 
usually,  the  proposed  method  of  financing,  manner  of  mainten- 
ance, and  the  necessity  of  the  undertaking.  After  the  termina- 
tion of  the  period  of  proper  notification,  the  court  in  most  states 
holds  a  public  hearing  to  determine  the  competency  of  the  peti- 
tioners and  the  validity  of  their  petition.  If  a  favorable  deci- 
sion is  reached  by  the  court,  provision  is  first  made  for  the 
creation  of  the  administrative  body. 

The  more  common  practice,  after  the  officials  who  are 
elected  or  appointed  by  the  court  have  formally  organized 
their  board,  is  for  this  board  to  proceed  to  make  a  preliminary 
examination  of  the  district  to  determine  whether  the  benefits 
which  may  accrue  to  the  lands,  warrant  the  cost  of  construc- 
tion, maintenance  and  damages  to  other  lands  and  right  of  way. 
In  some  states  the  commission  has  jurisdiction  of  dismissal  if 
the  costs  are  found  to  be  greater  than  the  probable  revenue, 
though  appeals  may  be  made  to  both  the  jurisdictional  courts 
and  then  to  the  higher  courts.  If  the  project  is  approved  by 
the  commissioners,  a  definite  plan  of  improvement  is  made  on 
the  basis  of  the  surveys,  together  with  the  proposed  method  or 
methods  of  financirg.  After  a  report  is  again  submitted  and 
reviewed  by  special  officers  of  the  court,  a  public  hearing  can 
be  requested  by  the  people  after  statutory  notice  has  been 
given.  Any  land  owner  in  the  district  can  present  evidence  of 
his  approval  of  or  objections  to  the  assessments  to  be  made 
upon  all  or  any  part  of  the  land  included  within  the  area  pro- 
posed. The  court,  which  has  the  power  of  amending  these 
articles,  then  renders  a  judgment,  and  where  it  approves,  allows 
the  board  to  assess  all  lands  in  the  district  in  accordance  with 
the  terms  rendered  in  the  decision.  This  judgment  can  again 
be  appealed  to  a  higher  court  by  any  of  the  affected  parties. 
The  plans  having  been  given  the  final  approval,  the  commis- 
sioners then  proceed  to  secure  funds  for  financing.  Where  the 
expenditures  are  large,  funds  must  be  secured,  as  with  other 
civil  obligations,  by  long  time  bonds.  After  the  districts  have 
been  organized,  the  issuance  of  bonds  is  the  next  step.  The 
methods  of  issuance  vary  a  great  deal,  but  the  underlying 
security  of  the  bonds  is  not  affected  by  the  method  of  issuance. 


DRAINAGE  AND  LEVEE  543 

Security.1 — It  is  needless  to  say  that  no  improvement  should 
be  undertaken  unless  the  resulting  benefits  greatly  exceed  the 
cost  of  the  project.  This  requisite  makes  it  incumbent  upon  the 
officials  of  the  jurisdiction  to  place  a  tax  upon  each  farm  on  the 
basis  of  benefits  received  from  drainage.  For  illustration,  if  an 
improved  farm  within  the  border  of  a  drainage  district  requires 
less  drainage  than  other  farms,  it  should  be  taxed  less  in  sup- 
port of  the  drainage  system,  since  the  benefits  received  are  less. 
While  this  is  the  only  equitable  method  of  distribution,  it  may 
in  some  instances,  where  the  benefits  largely  accrue  to  a  small 
area  of  the  drained  district,  make  the  tax  rather  burdensome 
and  it  may  even  lessen  the  stability  of  the  security.  While  this 
situation  seldom  occurs,  when  it  does  arise,  it  may  become  very 
embarrassing. 

The  success  of  the  project  should  not  be  made  dependent 
entirely  on  the  success  of  the  drainage  area  in  land  selling,  as 
has  been  the  case  with  a  goodly  number  of  irrigation  enter- 
prises. If  colonization  is  necessary,  the  bond  issue  is  rarely 
very  desirable.  Unsettled  areas  are  always  subject  to  so  many 
problems  that  the  risk  becomes  more  than  correspondingly 
indeterminate  and  puts  the  securities  within  the  speculative 
class. 

Where  the  security  is  not  sufficient  to  warrant  the  issuing 
of  bonds  for  constructing  drainage  facilities  and  offering  them 
to  the  general  public  before  the  project  is  built,  but  where  it  will 
be  sufficient  when  the  area  is  drained  and  the  land  has  been 
under  cultivation  for  some  time  a  bond  issue  might  be  marketed. 
This  procedure,  however,  is  usually  impractical,  especially  where 
the  district  is  one  of  small  land  owners,  as  they  do  not  have  the 
funds  to  carry  out  the  project. 

Levee  district  bonds,  as  a  class,  can  never  offer  the  same 
assured  safety  as  drainage  issues  where  the  drainage  project 
securing  the  bonds  requires  but  little  or  no  protection  from  levee 
construction.  A  levee  is  always  more  or  less  in  danger  of  extraor- 
dinary floods  and  the  consequent  destruction  of  a  very  large 

*It  is  hardly  deemed  necessary  to  discuss  the  security  of  the  city 
drainage  or  county  "ditch  bonds."  which  are  adequately  covered  under 
special  assessments. 


544  INVESTMENT  ANALYSIS 

part  of  the  crops  and  improvements  on  its  area.  As  the  pay- 
ment of  taxes  is  dependent  upon  the  earning  power  of  the  area, 
such  a  large  destruction  of  property  in  the  early  period  of  an 
issue  might  cause  at  least  a  temporary  suspension  of  interest 
payments.  But  owing  to  the  fact  that  the  Federal  government 
has  done  the  major  part  of  the  levee  building  in  the  region  south 
of  St.  Louis,  Missouri,  to  the  mouth  of  the  Mississippi  (which 
region  includes  the  greater  part  of  levee  building  in  the  United 
States)  the  experience  of  local  civil  division  has  been  consid- 
erably limited. 

As  officials  usually  have  no  experience  in  drainage  problems, 
it  is  very  essential  that  the  statutes  governing  the  administra- 
tion cover  rather  specifically  the  power  and  limitation  of  the 
officials'  authority,  and  penalties  should  be  made  severe  for  non- 
compliance  to  duty.  Consequently,  receipts  and  expenditures 
should  be  frequently  audited  to  check  quickly  the  development 
of  any  serious  mistake  that  may  arise,  especially  during  the 
period  of  construction. 

The  importance  of  the  character  of  construction  to  the 
future  success  of  the  district  is  obvious  and  necessitates  the 
employment  of  a  reputable  engineer  to  pass  upon  all  details  of 
construction.  To  guarantee  further  safety,  not  only  should  a 
reliable  contractor  and  agent  be  engaged,  but  the  contractor's 
surety  bonds  should  be  drawn  so  as  to  give  full  protection  by 
covering  all  reasonable  losses. 

Taxes. — The  tax  of  the  district  should  be  secured  by  a  fixed 
lien  upon  the  property  benefited.  A  sufficient  margin  for  any 
exigency  should  be  allowed  above  the  total  funded  indebted- 
ness. The  more  conservative  statutes  limit  the  funded  debt  of 
a  district  to  90  per  cent  of  the  tax  levy.  But  the  percentage  of 
the  funded  debt  to  the  tax  levy  is  rather  meaningless  unless  the 
benefits  and  value  of  land  are  also  compared  to  the  tax  levy. 
For  example,  a  tax  levy  of  $2.00  per  acre  upon  land  valued  at 
$75.00  per  acre,  would  have  little  basis  for  comparison  with  a 
tax  levy  of  $2.00  upon  land  valued  at  $8.00  per  acre.  The  chief 
danger,  however,  lies  in  the  overvaluation  of  the  land,  for  this 
again  destroys  the  significance  of  the  tax  levy  ratio.  The  temp- 
tation, of  course,  is  always  great  to  inflate  the  valuation  of  the 


DRAINAGE  AND  LEVEE  545 

cheaper  land,  or  to  cover  up  a  large  acreage  of  undesirable  land 
by  a  general  average,  but  when  reputable  agents  and  engineers 
are  employed,  the  danger  of  this  is  reduced  to  a  minimum. 

The  annual  taxes  should  also  be  sufficient  to  cover  all 
maintenance  charges;  the  limitations  and  regulation  of  these 
charges  should  be  fully  set  forth  in  the  statutes  together  with 
provisions  enforcing  the  proper  expenditures  of  this  fund  by 
district  officials.  Several  of  the  earlier  statutes  stated  these 
requirements  in  such  vague  form,  especially  those  relating  to 
the  administration  of  funds,  that  a  misunderstanding  of  them 
often  resulted  in  considerable  embarrassment  to  the  district. 

Mr.  J.  Sheppard  Smith's  statement  concerning  the  Missouri 
law  is  well  worth  detailed  study: 

"Bonds  may  be  issued  not  to  exceed  90  per  cent  of  the  total 
taxes  levied  with  interest  not  exceeding  6  per  cent  per  annum 
payable  semi-annually  maturing  serially  for  twenty  years,  be- 
ginning not  later  than  five  years  after  date.  Such  bonds  can- 
not be  sold  for  less  than  ninety-five  cents  on  the  dollar  and 
accrued  interest.  ...  In  the  event  of  failure  of  the  proceeds 
resulting  from  the  sale  of  land  for  taxes  proving  sufficient  to 
pay  the  delinquent  taxes,  the  board  of  supervisors  has  the  right 
to  levy  an  additional  tax  on  the  entitfe  district  to  make  up  the 
deficit  and  which  in  effect  provides  for  a  thorough  safeguard  TO 
the  investor  for  the  full  payment  of  principal  and  interest  in 
accordance  with  the  tenure  of  the  bonds." 

As  emphasized  under  the  topic  of  "Security,"  a  failure  to 
make  provision  for  this  exigency  may  prove  fatal  to  the  enter- 
prise. Several  of  the  statutes  either  set  up  no  safeguard  against 
such  emergencies  or  the  statutes  have  so  regulated  the  matter 
that  any  lack  of  funds  throws  the  whole  affair  into  the  courts. 
And  the  possibility  of  long  drawn  out  court  proceedings  does 
not  add  to  the  value  of  any  security.  Fortunately,  in  all  read- 
justments the  courts  are  now  inclined  to  make  broader  inter- 
pretations of  the  statutes.  This  is  shown,  for  example,  in  the 
limited  powers  granted  to  the  drainage  districts  to  tax  in  the 
early  history  of  the  development  of  this  industry.  Allowing  an 
organized  district  to  levy  a  tax  for  the  improvement  of  privately 


.,  pp.  100-107. 


546  INVESTMENT  ANALYSIS 

owned  lands  was  never  countenanced.  This  narrow  attitude  has 
changed,  and  where  public  welfare  is  involved,  the  statutes 
prohibiting  this  form  of  control  are  being  corrected.  Where, 
however,  the  statutes  lack  definiteness,  court  decisions  must  be 
more  closely  checked. 

The  Market. — While  the  market  for  these  bonds  has  greatly 
increased  in  recent  years,  it  cannot  even  yet  be  called  a  broad 
one.  The  drainage  issues  of  the  Mississippi  Valley,  which  twenty 
years  ago  were  never  considered  by  New  York  bankers,  are  now 
looked  upon  with  favor  when  properly  issued.  Especially  are 
those  issues  sought  which  have  the  same  tax  rights  and  privi- 
leges as  other  municipal  issues  within  the  state.  The  greater 
part  of  the  drainage  bonds,  however,  continue  to  be  absorbed 
locally.  A  considerable  number  of  these  issues  will  be  found 
listed  under  the  "investment  fund"  item  of  state  banks,  trust 
companies  and  insurance  companies  of  the  issuing  states. 

The  net  yield  of  these  issues,  as  a  whole,  is  higher  than  that 
of  other  forms  of  special  assessment  bonds,  though  the  average 
return  of  all  city  and  county  districts,  including  ditch  (drain- 
age) bonds  is  lower.  Levee  bonds,  however,  even  in  the  same 
general  area,  will  compare  unfavorably  with  drainage  issues. 

The  majority  of  these  bonds  are  now  issued  in  serial  form. 
Even  where  the  commissioners  possess  the  option  of  issuing 
sinking  fund  or  serial  payment  bonds,  the  usual  practice  is  to 
use  the  serial  forms.  The  maturities  range  from  one  (serial 
issues)  to  fifty  years  with  no  conformity  in  duration.  The 
average  maturity  is  about  twenty  years.  Under  no  considera- 
tion should  the  bond  extend  to  the  end  of  the  life  of  the  im- 
provement. 

The  United  States  Treasury  Department  has  ruled  that 
drainage  and  levee  districts  shall  be  classed  as  civil  divisions. 
This  exempts  drainage  bonds  from  the  Federal  income  tax. 


BOOK  IV 
CIVIL  OBLIGATIONS 


CHAPTER  XXXIII 

THE  ISSUING  POLITICAL  UNIT  AND  THE  SECUEITY 
OF  ITS  BOND  ISSUES 

The  content  of  these  chapters  on  civil  obligations  is  pre- 
sented primarily  from  the  standpoint  of  the  individual  pur- 
chaser of  these  securities  rather  than  of  the  institutional  buyer. 
While,  as  a  class,  they  are  accepted  as  the  safest  of  bonds,  the 
legal  technicalities  which  so  largely  determine  their  safety  make 
them  the  most  difficult  to  analyze.  Much  material  which  would 
be  valuable  in  their  presentation  cannot  be  included  within  the 
limits  of  these  chapters.  Especially  does  this  apply  to  the  many 
differences  in  statutes  controlling  these  issues. 

Municipal1  securities  did  not  have  a  very  wide  appeal  in 
the  general  security  market  until  fifteen  years  ago.  The  low 
yield  and  the  safety  of  these  bonds  entirely  removed  them  from 
the  speculative  class.  The  safety  of  the  bonds,  while  directly 
due  to  the  state  constitutions  and  statutes,  is  also  the  result,  to 
a  very  large  degree,  of  the  efforts  of  the  municipal-bond  attor- 
ney in  his  codification  of  the  law  and  his  power  to  eliminate 
faults  in  the  procedure  of  municipalities  in  issuing  their  bonds. 
The  average  layman  who  ordinarily  makes  a  careful  examina- 
tion of  all  other  classes  of  issues  purchased,  passes  over  the  tech- 
nicalities and  accepts  unquestioningly  the  security  of  a  munici- 
pal bond  which  qualifies  as  a  legal  investment  for  savings  banks. 
But  though  the  investor  has  secured  a  bond  of  unquestioned 
safety,  he  might  secure  equal  safety  with  a  higher  rate  of 
return  by  purchasing  other  municipal  issues.  With  tax-exemp- 
tion privileges  of  municipal  bonds  under  the  Federal  income 


'The  term  municipal  bonds  as  used  here  includes  the  bond  issues  of 
all  the  political  divisions  of  the  state. 

549 


550  INVESTMENT  ANALYSIS 

tax  law  and  within  the  state  of  issue  itself,  individual  investors 
are  no  longer  disregarding  the  advantages  of  municipal  bonds 
which  possess  equal  safety  and  many  of  which  afford  a  higher 
rate  of  return  than  those  municipal  bonds  qualifying  as  savings 
bank  investments.  As  a  result,  a  closer  scrutiny  of  the  tax  laws 
affecting  them  and  the  elements  determining  their  safety  will 
be  made  in  the  future  by  purchasers.  With  this  general  state- 
ment let  us  pass  on  to  an  examination  of  what  enters  into  the 
analyses  of  civil  obligations. 

Jurisdiction  and  Function  of  Civil  Divisions  as  Related  to 
the  Powers  to  Finance  Themselves. — The  authority  of  civil  divi- 
sions refers  here  only  to  their  financial  powers,  rights,  and  limi- 
tations. The  common  civil  divisions  possessing  the  authority 
to  assume  financial  obligations  and  to  issue  bonds  which  are 
payable  from  either  an  ad-valorem  tax  or  by  special  assessment 
on  the  property  benefited  are  the  Federal  government,  the  state, 
and  the  civil  divisions  of  the  state;  namely,  the  county,  town- 
ship, borough,  parish,  precinct,  city,  town,  village,  and  district 
(i.  e. — schools,  roads,  drainage,  levee  and  bridge  districts). 

Of  these  jurisdictions,  the  Federal  and  state  governments  are 
peculiarly  distinctive.  Neither  one  of  these  powers  can  be 
forced  to  pay  its  obligations  if  it  chooses  not  to  do  so.  The 
Federal  government  can  borrow  for  any  purpose  it  desires  and 
the  states  are  limited  only  by  restrictions  which  may  involve 
inter-state  activities  as  long  as  these  powers  are  granted  under 
their  constitutions.  Within  a  state's  own  borders  its  power  to 
borrow  is  as  absolute  as  that  of  the  national  government.  It  is 
true  that  the  state  can  place  certain  limitations  upon  itself,  but 
it  has  equal  power  to  remove  these  self-imposed  restrictions. 

The  powers  and  rights  of  the  civil  divisions  of  the  state,  on 
the  other  hand,  have  been  rather  definitely  limited,  especially 
in  the  question  of  assuming  debt.  This  power  is  given  by 
the  state  and  can  either  be  taken  away  or  reduced  by  the  state. 
Neither  have  the  minor  civil  divisions  the  power  to  refuse  the 
payment  of  a  legal  debt.  If  they  refuse  payment  of  an  obliga- 
tion, they  are  subject  to  court  action,  and  the  court  can  enforce 
the  payment  of  any  legal  debt  which  they  have  assumed.  The 
first  problem  then,  in  a  study  of  the  finances  of  these  political 


ISSUING  POLITICAL  UNIT  551 

divisions  of  the  state  is  an  examination  of  the  character,  im- 
portance, and  general  powers  of  these  respective  divisions. 

In  geographical  area  the  county1  is  largest,  though  not 
always  the  most  important,  of  the  state's  political  divisions. 
Delaware,  with  three  counties,  has  the  smallest  number  of  these 
divisions  of  any  state,  and  Texas,  with  two  hundred  and  forty- 
five,  the  largest  number.  In  area  they  vary  from  Bristol 
County,  Ehode  Island,  with  twenty-five  square  miles,  to  Custer 
County,  Montana,  with  twenty  thousand  four  hundred  and 
ninety  square  miles.  The  population  shows  an  even  wider 
range  from  New  York  and  Cook  counties  with  their  millions  to 
some  of  the  sparsely  populated  counties  of  Arizona,  New  Mexico 
and  western  Texas.  In  five-eighths  of  the  Western  states  the 
counties  have  a  population  of  less  than  15,000  inhabitants. 
From  one-fifth  to  one-sixth  of  the  counties  in  the  United  States 
contain  cities  of  more  than  8,000  people.  But  in  many  of  these 
counties  the  rural  population  exceeds  the  urban.  This  domi- 
nance of  either  rural  or  urban  population  has  a  marked  effect 
on  the  bond  issues  of  these  political  divisions.  The  presence  of 
a  moderate-sized  municipality  in  the  county  may  largely  in- 
crease the  credit  of  the  county.  "Where  the  city  includes  the 
greater  percentage  of  the  population  in  the  county,  the  city 
automatically  decreases  the  amount  of  obligations  that  the 
county  would  ordinarily  assume.  For  example,  practically  all 
police  and  administration  expenditures  would  fall  within  the 
metropolitan-area  of  the  county. 

As  an  administrative  and  legislative  fiscal  agent,  the  county 
is  quasi-corporate  in  character.  The  specific  fiscal-powers  are 
given  by  the  constitution,  statutory  and  common  law  but  chiefly 
by  statutes.  In  some  states  there  is  a  partial  supervision  of 
county  finances  by  state  officers,  but  this  form  of  administration 
has  been  unsuccessful.  The  powers,  on  the  other  hand,  con- 
ferred on  the  city  governments  are  both  more  comprehensive 
and  elastic  than  the  rights  conferred  on  county  governments. 
This  has  normally  risen  out  of  the  fact  that  the  city  has  a  far 
greater  number  of  common  interests  than  the  county,  and  while 


*In  the  state  of  Louisiana,  these  divisions  are  called  parishes  in- 
stead of  counties. 


552  INVESTMENT  ANALYSIS 

the  cities  have  been  expanding,  the  counties  have  rarely  had 
their  jurisdiction  extended. 

The  purposes  for  which  county  expenditures  and  obligations 
may  be  assumed  have,  consequently,  in  most  states,  been  quite 
clearly  defined.  This,  together  with  the  limitations  placed  upon 
the  rate  of  assessment  allowed  and  the  amount  of  debt  incurred, 
greatly  narrows  the  expenditures  that  a  county  may  make. 

In  administrative  and  legislative  powers,  the  county  is 
strongest  in  the  Southern  and  Western  states  and  weakest  in 
New  England,  where  the  old  town  government  predominates. 
The  Middle  Atlantic  states  divide  these  functions  between  the 
county  and  the  township.  This  dominance  of  the  county  in  the 
South  and  West  has  arisen  out  of  local  conditions.  The  South- 
ern and  the  Western  groups  which  comprise  the  larger  part  of 
the  geographical  area  of  the  United  States  are,  with  the  excep- 
tion of  a  few  industrial  and  commercial  centers,  predominantly 
rural.  Consequently,  the  county  government,  especially  in  the 
South,  has  been  found  to  be  the  simplest  and  most  expedient 
of  the  minor  political  divisions  for  the  performing  of  govern- 
mental functions.  In  these  regions  the  county  has  had  to  pro- 
vide for  many  of  the  improvements,  such  as  roads,  institutional 
buildings,  etc.,  which  are  assumed  by  state,  township,  city,  town, 
or  tax  districts  in  other  regions. 

The  fact  that  the  counties  of  the  Western  Middle  Atlantic 
and  Northern  Atlantic  group  of  states  as  classified  by  the 
United  States  census,  together  with  two  or  three  counties  in 
the  New  England  states,  lead  in  the  absolute  amount  of  expen- 
ditures, should  not  deceive  one  as  to  the  importance  of  the 
indebtedness  and  expenditures  of  the  counties  in  the  Southern 
group  of  states.  The  expenditures  and  indebtedness  of  a  county 
must  be  considered  in  relation  to  its  population  and  wealth, 
and  to  the  expenditures  and  indebtedness  of  the  overlapping 
political  jurisdictions. 

The  township,  like  the  county,  is  a  quasi-municipal  corpora- 
tion created  by  law.  Unlike  the  village  or  city,  which  is  volun- 
tarily created  by  its  inhabitants,  the  two  former  civil  units  are 
formed  on  geographical  boundaries.  In  area  the  township  is 
more  nearly  equal  in  the  Middle  West  and  Far  West,  and  it  is 


ISSUING  POLITICAL  UNIT  553 

in  these  states  that  this  form  of  political  division  has  its  highest 
organization.  The  importance  of  the  township  from  a  financial 
viewpoint  depends  altogether  on  whether  it  is  rural  or  metro- 
politan in  character.  A  large  city  will  sometimes  include  the 
whole  of  a  township  six  miles  square.  The  corporate  and  finan- 
cial power  of  the  township  is  narrowly  limited.  In  some  states 
it  has  no  corporate  power  and  cannot  enter  into  contracts.1 
Where  the  township  has  no  right  to  issue  bonds,  these  functions 
are  usually  performed  by  either  a  county  or  special  tax  district. 
The  purposes  for  which  issues  are  most  commonly  permitted 
are  for  schools  and  roads.  In  most  instances  the  township-school 
district  is  entirely  independent  of  the  township  government,  and 
coincides  with  it  only  in  geographical  area. 

The  town  system  of  New  England,  the  forerunner  of  the 
township,  is  similar  to  some  of  the  township  organizations  and 
possesses  somewhat  equivalent  powers  in  the  issue  of  bonds  for 
local  purposes.  However,  the  creation  of  incorporated  cities 
and  towns  has  taken  away  from  the  old  town  system,  except  in 
the  exclusively  agricultural  regions,2  the  importance  it  once 
possessed. 

The  political  divisions  which  can  be  classed  under  munici- 
palities are  incorporated  cities,  towns,  and  villages,  though  a 
discussion  of  municipal  finances  often  embraces  all  divisions 
of  the  state,  including  the  county.  The  classification,  however, 
must  not  be  too  inclusive  or  exclusive,  for  both  court  decisions 
and  statutes  do  not  exclusively  follow  the  one  or  the  other.  But 
the  economic  significance  is  important.  The  fact  that  a  city, 
town,  or  village  is  placed  under  the  general  classification  of 
a  municipality,  gives  no  indication  of  its  financial  importance. 
Size,  location,  wealth,  character  of  industries,  volume  of  com- 
merce, etc.,  are  necessary  qualifications  of  any  general  classi- 
fication of  municipalities  in  relation  to  their  ability  to  issue  and 
pay  for  bonds.  While  the  general  power  to  levy  taxes  and  to 
contract  debts  may  be  given  by  the  constitution  or  statute  to  all 


'Harshman  vs.  Bates  County,  92  TJ.  S.  569,  23  L.  ed.  747. 

"The  creation  of  the  special  tax  district  and  its  powers  which  might 
well  be  included  under  the  discussion  of  the  jurisdiction  and  powers  of 
Civil  Divisions,  are  discussed  in  chap,  xxxiv. 


554  INVESTMENT  ANALYSIS 

of  these  political  units,  the  financial  strength  of  the  unit  depends 
upon  the  factors  referred  to  in  the  preceding  sentence.  What 
comparison,  for  example,  is  there  between  a  bond  issue  of  a 
remote  village  of  1,000  inhabitants  in  western  Kansas  and  an 
issue  of  the  city  of  Philadelphia ;  or  between  the  street  improve- 
ment bonds  of  a  town  of  2,000  in  Texas  and  a  similar  issue  in 
Worcester,  Massachusetts  ? 

Physical  Resources. — The  credit  of  a  state  or  other  civil 
division  is  largely  dependent,  as  experience  has  shown,  on  the 
manner  in  which  it  manages  its  obligations,  though  both  the 
amount  and  security  of  the  debt  are  ultimately  limited  by  the 
number  of  the  inhabitants  and  the  resources  of  the  state.  While 
the  Northwestern  states  have  been  largely  peopled  by  the  sturdy 
races  of  northern  Europe,  the  wealth  of  Iowa,  Wisconsin,  Min- 
nesota, and  the  Dakotas  could  not  have  been  the  heritage  of 
these  states  today  if  those  people  had  not  found  rich  fertile  soils 
and  abundant  minerals  to  develop.  But  people  themselves,  in 
the  broader  sense  of  the  term,  must  be  considered  a  resource  of 
a  state.  Though  statistical  proof  has  never  been  offered,  many 
would  assert  that  the  colored  population  in  some  of  the  South- 
ern states  has  had  an  effect  on  state  credit,  especially  in  certain 
minor  civil  divisions  of  these  states. 

Increase  in  numbers  obviously  must  lead  to  greater  develop- 
ment of  natural  resources  followed  by  the  growth  of  commerce 
and  industry,  as  population  will  automatically  be  checked  un- 
less resources  exist  by  which  a  people  may  obtain  subsistence. 
The  Pacific  Coast  states  and  the  Northwestern  states,  for  ex- 
ample, have  paralleled  their  growth  with  an  increasingly  strong 
credit.  Increased  farming  facilities  and  improved  machinery 
in  the  agricultural  states  have  effected  greater  efficiency.  The 
metal  refining  industries  were  originally  located  on  the  eastern 
seaboard,  because  this  was  the  great  market  for  these  products. 
Likewise  the  presence  of  wheat  in  the  surrounding  territory, 
together  with  power  facilities,  established  the  great  milling  in- 
dustries at  St.  Paul  and  Minneapolis.  The  presence  of  water- 
power  and  the  labor  supply  in  the  mountains  of  Carolina  made 
possible  the  development  of  the  spinning  industry  of  the  Caro- 
linas.  The  discovery  of  iron  in  Alabama  developed  a  rural  ter- 


ISSUING  POLITICAL  UNIT  555 

ritory  into  the  great  industrial  center  of  Birmingham,  and  all 
of  these  developments  have  to  a  corresponding  degree  increased 
the  taxable  wealth  of  these  localities.1 

This  last  statement  does  not  imply  that  natural  resources 
in  the  narrow  sense  are  essential  as  a  basis  of  credit.  Massa- 
chusetts, which  has  the  very  poorest  agricultural  land,  has  had 
large  advantages  through  its  geographical  position.  Its  coast 
frontage  gave  it  not  only  a  climate  whose  moisture  made  it 
possible  to  build  up  a  great  textile  industry,  but  the  means  of 
cheap  water  transportation  which  was  so  essential  in  the  earlier 
days. 

But  all  states  have  not  been  equally  endowed  with  resources. 
For  example,  among  the  newer  states,  the  Dakotas  can  never 
hope  to  compete  with  Illinois  because  of  the  advantages  pos- 
sessed by  the  latter  in  its  peculiar  geographical  position,  which 
gives  it  the  advantages  of  transportation  and  easy  access  to  raw 
materials.  It  is  true  that,  where  they  exist,  these  very  advan- 
tages may  lead  to  excesses,  while  the  state  not  so  richly  endowed 
will  tend  toward  a  greater  conservatism.  But  a  state  with  a 
very  limited  endowment  of  such  resources,  as  are  essential  to 
great  stability,  can  never  have  a  very  large  margin  to  fall  back 
upon  in  case  of  emergency.  The  ability  of  any  people  to  pay 
their  taxes  to  the  sovereign  power  after  their  own  necessities 
have  been  supplied  ultimately  rests  on  the  annual  surplus  they 
acquire.  It  is  evident,  then,  that  no  general  rule  can  be  laid 
down.  Any  statistical  study  and  analysis  must  ascertain  the 
importance  that  can  be  attached  to  each  factor  under  varying 
conditions  and  combinations.  Only  a  true  historical  perspective 
can  give  this. 

It  is  important  to  know  both  the  character  and  diversifica- 
tion of  resources  and  industries  in  any  one  of  the  minor  civil 
divisions  of  the  state.  Towns  which  are  dependent  upon  one 
industry  are  likely  to  suffer  most  severely  from  periods  of  de- 
pression. When  this  one  industry  shuts  down,  there  is  nothing 
left  to  furnish  employment.  Some  of  the  towns  established  in  the 
timber  regions  have  practically  been  depleted  when  the  timber 


Mayor  vs.  Ray,  19  Wall  468, 


556  INVESTMENT  ANALYSIS 

supply  has  been  cut.  Towns  dependent  upon  agriculture  are 
less  likely  to  suffer  from  depression  and  reactions  than  towns 
which  depend  upon  any  of  the  other  natural  resources,  and  if 
crops  are  depleted  one  year,  the  same  condition  is  not  likely  to 
be  repeated  the  following  year.  Other  things  being  equal,  the 
size  of  a  city  or  town  is  an  advantage  in  agricultural  regions 
as  well  as  in  territory  of  any  other  character.  There  is  also  an 
increase  in  the  diversification  of  industries  with  the  increase 
in  the  size  of  the  city,  and  this  more  than  correspondingly 
strengthens  the  ability  of  the  city  to  pay  its  obligations. 

Financial  Resources. — The  strength  and  growth  of  private 
financial  institutions  are  the  direct  indicators  of  the  financial 
resources  of  the  public.  The  amount  of  capital,  surplus,  and 
deposits  of  banks,  and  the  value  and  character  of  insurance  and 
trust  companies,  rather  than  the  number  of  banks  and  the 
amount  of  policies  written,  are  examples  of  the  true  indices  of 
financial  stability.  Bank  clearings  may  or  may  not  be  a  good 
basis  for  judging  a  community's  business.  If  the  clearings  are 
from  states  like  New  York  and  Massachusetts,  they  can  be 
accepted  as  reliable,  but  if  they  are  taken  from  some  of  the 
Rocky  Mountain  states,  where  clearings  may  be  estimated  on  the 
basis  of  reporting  national  banks,  or  where  the  banks  are  chiefly 
state  or  private,  the  totals  rendered  are  very  likely  to  be  in- 
correct. Debit  balances,  as  suggested  in  the  chapters  on  Market 
Influences  of  Security  Prices,  would  be  a  better  criterion  than 
bank  clearings  because  of  the  limited  value  which  bank  clear- 
ings now  possess  for  indicating  the  volume  of  business  under 
the  Federal  Reserve  System.  Insurance  companies  are  of  im- 
portance in  so  far  as  they  create  a  market  for  securities  issued 
within  the  state.  If  the  insurance  company  is  very  large,  a 
considerable  part  of  its  investments  and  policies  will,  of  course, 
be  held  outside  of  the  state. 

A  study  of  the  United  States  Comptroller's  reports  reveals 
an  astounding  growth  in  the  capital  and  deposits  of  banks  in 
the  last  thirty  years.  The  questions  at  once  arise :  Can  this 
growth  continue  in  all  localities?  What  states,  if  any,  show 
inflation?  Has  the  growth  been  consistent  or  will  local  condi- 
tions finally  force  a  reaction  ?  Has  the  maximum  point  of  rapid 


ISSUING  POLITICAL  UNIT  557 

growth    been    reached    and    will    any    increase    be    relatively 
slower  ? 

The  importance  of  the  emphasis  placed  upon  the  financial 
strength  of  the  smaller  civil  divisions  in  the  state  is  well  illus- 
trated by  the  experience,  a  few  years  ago,  of  a  small  Middle 
"Western  city.  A  political  element  which  was  in  control  of  the 
state  census  and  had  local  real  estate  that  it  wanted  to  promote, 
succeeded  in  inflating  the  census  figures.  Closely  following  this 
census,  bonds  were  issued  by  the  city.  Five  years  later  the 
Federal  census  was  taken,  and  it  showed  a  large  falling  off  in 
population  from  the  previous  state  census.  Immediately  upon 
the  publication  of  this  fact,  the  holders  of  some  of  these  bonds 
became  apprehensive  and  the  price  of  the  bonds  slumped.  The 
issuing  house,  after  going  over  the  local  situation,  discovered 
that  despite  the  fact  that  population  statistics  represented  the 
toAvn  as  having  a  smaller  number  of  inhabitants  than  it  had  five 
years  earlier,  bank  clearings  and  deposits  showed  large  in- 
creases. The  day  following  the  announcement  of  this,  the  price 
of  the  bonds  moved  up  to  its  former  level,  for  all  question,  as 
to  the  city's  financial  stability  was  removed. 

Other  Resources. — Other  resources — that  is  other  than  the 
right  of  taxation  yielding  revenue — of  any  of  the  political  divi- 
sions in  the  United  States,  have  never  been  large.  Neither  the 
United  States  nor  the  state  governments  have  ever  entered  into 
an  extensive  control  of  private  enterprises.  Though  the  emer- 
gency demands  of  the  European  War  instituted  a  temporary  re- 
versal of  this  policy,  the  control  exercised  was  chiefly  regula- 
tory. The  individualism  which  has  become  so  deeply  ingrained 
under  a  long  continued  democracy  will  be  slow  to  surrender 
permanently  any  control  to  Federal  and  state  governments. 
The  immediate  result  of  the  War  in  many  particulars,  though  it 
is  too  early  to  predict,  will  be  a  tendency  to  cling  more  tena- 
ciously to  the  former  type  of  organization.  In  the  past  the  sale 
of  public  land  has  furnished  the  largest  source  of  gross  in- 
come other  than  taxation  to  both  the  Federal  and  the  state 
governments.  The  lack  of  business  sagacity  so  often  displayed 
in  government  management  has  resulted  in  an  exceedingly  sma1! 
return  from  the  sale  of  this  land.  Of  the  land  donated  to  the 


558  INVESTMENT  ANALYSIS 

states,  two  sections  in  every  township  were  given  for  school 
purposes,  and  the  policy  followed  has  been  to  dispose  of  it  as 
quickly  as  possible  at  a  large  sacrifice.  Within  the  city  limits 
of  Chicago,  for  example,  nine  sections  of  land  were  originally 
set  aside  for  school  purposes.  If  this  land  had  been  held  it 
would  now  furnish  more  ample  funds  than  are  provided 
through  taxation  by  the  city.  Little  remains  of  these  former 
holdings.  The  income  which  will  be  derived  from  forest  and 
mineral  preserves  will  also  continue  to  be  relatively  small. 

The  income  from  public  utilities  is  usually  put  in  the  form 
of  a  privilege  tax  and  not  as  a  rental,1  with  the  exception  of 
such  properties  as  docks,  wharves,  and  ferries  which  are  gen- 
erally leased.  The  payment  of  a  certain  percentage  of  the  net 
receipts  of  the  public  utility  corporation  is  giving  some  munici- 
palities a  considerable  income.  The  depression  of  public  utility 
earnings  (at  the  present  writing)  which  has  made  considerable 
inroads  in  the  returns  cannot  continue  permanently,  for  such 
corporations  must  be  enabled  to  earn  revenue  on  invested  capi- 
tal, if  additional  capital  is  to  be  found  for  the  extensions  and 
betterments  necessary  to  provide  adequately  for  the  community. 

With  the  exception  of  water-works,  the  majority  of  the 
municipally  owned  plants  have  not  been  a  profitable  source  of 
income  to  the  municipality.  The  majority  of  the  water-works 
operated  by  municipalities  have  been  self-supporting,  approxi- 
mately five-sixths  of  the  revenue  from  public  utilities  has  come 
from  this  source.  A  number  provide  sufficient  income  to  meet 
a  portion  of  the  interest  on  other  indebtedness.  Even  though 
they  are  a  direct  obligation  of  the  city,  the  absolute  necessity 
of  a  water-system  has  tended  to  give  the  officers  in  control  of  the 
water-system  the  power  to  charge  rates  sufficiently  high  to 
make  them  self-sustaining.  The  precedent  of  custom  which 
has  demanded  that  water-works  be  self-sustaining  has  no  doubt 
been  a  large  influence  in  perpetuating  this  power. 

Large  property  holdings  which  are  tax-exempt — for  exam- 


1While  all  real  estate,  buildings,  equipment,  parks,  etc..  are  legit- 
imately carried  as  assets  in  the  municipal  statement,  they  are  not  in- 
come-yielding. But  who  shall  question  the  increased  efficiency  which  a 
park  system  and  play  grounds  contribute  to  a  metropolis? 


ISSUING  POLITICAL  UNIT  559 

pie  the  holdings  of  such  universities  as  Harvard,  Yale,  Cornell 
and  Northwestern — are  said  to  place  an  added  burden  on  the 
community.  But  what  of  the  additional  income  and  other 
added  wealth  which  these  institutions  and  others  in  similar 
cases  bring  to  the  community?  There  is  no  instance  in  the 
case  of  educational  institutions,  at  least,  in  which  the  income 
brought  to  the  community  has  not  more  than  offset  the  value 
of  the  tax-exempt  privilege. 

The  financial  condition  of  the  state  is  also  directly  reflected 
in  the  condition  of  its  treasury.  The  assets  (aside  from  the 
taxing  power)  that  offset  current  liabilities  or  fixed  obligations 
may  be  in  various  forms.  Some  states  carry  a  government 
school  fund  usually  in  the  form  of  school  bonds,  while  others 
hold  securities  either  as  an  asset  or  a  permanent  fund  for  some 
specific  purpose.  These  are  usually  railroad,  or  banking  securi- 
ties, or  bonds  of  other  states,  or  of  the  minor  civil  divisions  of 
the  state.  Some  states  hold  securities  in  projects  which  they 
have  either  assisted  or  wholly  financed ;  these  are  to  be  paid  for 
out  of  the  earnings  of  these  projects.  Their  value,  of  course, 
depends  on  the  success  of  the  project.  Usually  they  have  proved 
worthless. 

The  smaller  civil  divisions  within  the  state,  with  the  excep- 
tion of  a  possible  sinking  fund,1  rarely  carry  financial  balances 
in  the  form  of  large  security  holdings.  On  the  other  hand, 
the  strength  of  its  financial  institutions  is  relatively  even  more 
significant  in  a  small  civil  division  because  of  the  extent  to 
which  it  offsets  its  credit.  In  any  community,  large  industrial 
and  commercial  enterprises  are  always  found  concurrent  with 
any  great  strength  in  financial  resources.  The  effect  of  indus- 


1For  a  discussion  of  the  Sinking  Fund  see  the  chapter  on  Civil 
Debt.  "In  some  states  cities  borrowing  money  on  long-term  bonds  are 
required  by  statute  to  maintain  sinking  funds  with  investments,  and 
in  a  limited  number  of  states  cities  under  these  statutes  are  further 
required  to  maintain  a  separate  fund  for  the  amortization  of  each  bond 
issue.  In  states  without  such  laws  a  city  can,  at  its  discretion,  main- 
tain either  type  of  sinking  fund.  In  both  classes  of  states  an  Increasing 
number  of  officials  are  becoming  convinced  that  it  is  financially  inadvis- 
able to  maintain  sinking  funds  with  investments  and  are  advocating 
sinking  funds  of  the  second  type  or  the  issue  of  serial  bonds  to  obviate 
the  necessity  of  any  kind  of  sinking  fund"  (United  States  Census  Bu- 
reau, Financial  Statistics  of  Cities  orer  30,000  [1917],  p  101). 


560  INVESTMENT  ANALYSIS 

trial  depressions  upon  the  financial  institutions  of  a  community 
must  consequently  be  studied  eveu  more  carefully  than  in  the 
case  of  the  state.  Diversification;  character,  and  size  of  indus- 
tries show  their  immediate  effect  Upon  the  financial  conditions 
of  a  community. 

Population. — The  character,  size,  and  growth  of  a  com- 
munity give  an  immediate  basis  for  determining  the  possible 
ability  of  the  state,  county,  city,  or  town  ultimately  to  pay  a 
particular  bond  issue.  If  a  new  community  is  built  around  a 
single  industry  which  is  largely  dependent  upon  unskilled  or 
semi-skilled  workers,  this  community  cannot  offer  the  same 
security  of  good  faith  as  a  well-established  New  England  city. 
Likewise  the  bond  issue  of  a  small  Southern  city  or  town  whose 
population  is  chiefly  colored  would  possess  a  less  favorable  posi- 
tion than  that  of  a  similar  sized  city  of  New  York  state. 

Age  which  gives  stability  to  municipalities  must  not  be 
overlooked.  Towns  in  lumbering  and  mining  districts  which 
have  had  all  indications  of  permanency  have  practically  van- 
ished overnight,  and  needless  to  say,  debts  cannot  be  paid 
without  the  tax  payers  to  pay  them,  as  a  few  investment  bankers 
in  the  early  days  of  municipal  loans  in  the  Middle  West  found 
to  their  sad  experience.  Occurrences  of  this  sort,  though  they 
are  unlikely  today,  potentially  exist  in  certain  summer  and 
winter  resort  towns. 

In  civil  loan  bond  circulars,  growth  of  population  has  always 
been  used  as  an  indicator  of  the  security  of  the  issue,  and  pre- 
sumably will  continue  to  be  used.  The  growth  of  population  has 
been  so  constant  and  rapid  in  this  country  that  within  con- 
servative limits,  it  has  always  been  possible  to  estimate  the  in- 
crease in  total  numbers.  Whether  immigration  is  checked  in 
the  future  by  legislation  or  by  new  economic  conditions,  the 
normal  birth  rate  will  still  make  the  increase  large,  though  a 
considerable  slowing  up  must  be  expected.  Equally  important 
in  the  study  of  the  growth  of  population  are  the  questions  of  the 
concentration  and  distribution  of  population.  And  the  more 
dependent  a  community  may  be  upon  a  single  industry,  the 
more  important  does  it  become  to  know  the  details  of  the 
growth  and  movements  of  population. 


ISSUING  POLITICAL  UNIT  561 

Checks  on  estimates  are  especially  necessary.  The  opti- 
mistic, in  their  desire  to  have  sales  arguments,  are  frequently 
led  to  overstatements  concerning  the  growth  of  population. 
This  is  especially  true  where  approximations  are  made  between 
two  different  Federal  censuses.  State  censuses  issued  by  a  few 
states  during  the  ten  year  interval  of  the  Federal  censuses, 
school  directories  and  city  hall  directories  are  valuable  in  check- 
ing these  estimates.  Annexations,  especially  in  small  sized 
cities  of  the  Middle  West  and  Far  West  states,  have  frequently 
led  to  wrong  conclusions  as  to  the  actual  increase  of  the  munici- 
pality through  growth.  Any  conclusions  as  to  growth  must  be 
based  upon  the  combined  population  of  both  the  original  city 
and  the  annexation.  Also  the  smaller  the  civil  unit,  the  more 
essential  is  it  that  these  estimates  be  checked.  After  the  city 
has  passed  the  100,000  mark,  the  error  either  way  is  not  so  im- 
portant. A  large  city  also  means  greater  permanency  in  popu- 
lation and  diversity  in  industry,  and  where  the  size  of  the  city 
is  a  determinant,  the  bond  issues  of  large  cities  should  be  given 
precedence. 

In  the  county,  township,  and  other  civil  districts,  numbers 
are  as  essential  to  greater  safety  as  in  the  city.  As  large  con- 
centration of  population  is  possible  only  in  cities,  the  location 
of  a  city  in  a  county  very  materially  increases  the  value  of 
the  bonds  of  that  county  for  the  same  reason  that  the  bonds  of  a 
large  city  are  stronger  securities  than  those  of  a  small  city. 
And  no  one  can  pursue  the  study  of  civil  obligations  far  with- 
out emphasizing  this  distinction.  Where  the  city  in  a  county  is 
of  very  great  importance,  as  stated  under  a  previous  heading,  a 
major  portion  of  the  indebtedness  will  be  assumed  by  the  city 
instead  of  the  county,  and  in  a  few  counties  with  such  cities 
located  within  their  borders  no  funded  debt  will  be  carried. 
While  the  net  debt  per  capita  may  be  as  large,  the  fiscal  admin- 
istration will  usually  be  managed  more  wisely.  Even  where  the 
county  and  city  are  not  only  politically  separated,  but  do  not 
overlap,  county  administrators  are  more  apt  both  to  follow 
the  policies  of  the  city  government  and  to  seek  the  advice  of 
bankers  and  expert  counsel. 

Large  towns,  to  a  small  measure,  occupy  the  same  relation- 


562  INVESTMENT  ANALYSIS 

ship  to  the  townships  or  districts  in  which  they  are  located.  In 
this  case,  however,  the  influence  is  not  as  marked  as  the  influ- 
ence of  the  large  city  upon  the  credit  of  the  county.  Greater 
ability  in  administration  is  more  likely  to  be  found  in  the  guid- 
ance of  a  large  city's  financial  affairs  than  in  small  towns.  The 
town  and  county  control  from  the  administration  side  are  much 
the  same.  The  advantage  of  a  town  over  a  township  is  the 
larger  population,  and  on  this  alone — other  things  being  equal 
— should  emphasis  be  placed.  As  with  all  other  factors  which 
enter  into  the  analyses  of  all  civil  obligations,  the  township 
with  the  smaller  number  of  inhabitants  requires  more  careful 
weighing  of  other  influences. 

TJie  Financial  History  and  Integrity  of  the  Civil  Unit. — 
Twenty-five  years  ago,  repudiation  was  still  not  an  uncommon 
thing  among  the  minor  civil  divisions  of  the  state,  and  the  con- 
servative purchaser  of  a  Southern,  Middle  "West  or  Western 
municipality  required  an  especial  assurance  that  all  legal  re- 
quirements had  been  fully  met.  While  not  impossible,  there  is 
little  probability  of  the  repudiation  of  civil  debt  in  the  United 
States  today.  The  early  experience  of  unjustified  repudiation 
growing  out  of  wilfully  created  technicalities  forced  the  revision 
of  statutes,  as  well  as  a  more  careful  examination  by  the  legal 
counsel.  And  with  the  more  effective  standardization  of  civil 
bond  codes  and  decisions  this  danger  has  been  practically  elim- 
inated. Yet  who  would  dare  gainsay  that  the  bonds  of  a  county, 
municipality,  or  any  other  civil  division  which  has  never  re- 
pudiated and  has  always  promptly  met  its  obligations  are  not 
more  acceptable  than  those  of  the  two  well-known  counties  of 
Missouri  whose  local  election  issues  for  many  years  hinged 
upon  these  early  repudiations.  The  past  record  of  financial 
integrity  and  good  faith,  whether  the  experiences  of  half  a  cen- 
tury ago  are  unduly  emphasized  or  not,  has  a  very  large 
influence  on  the  acceptance  of  the  bond  issue. 

Fortunately  the  information  on  the  past  history  of  civil 
loans,  especially  defalcations,  has  been  fully  and  comprehen- 
sively treated.  The  Commercial  and  Financial  Chronicle,  which 
is  easily  accessible  in  all  important  libraries,  has  completely 
covered  the  history  of  municipal  bonds  since  its  first  issue,  and 


ISSUING  POLITICAL  UNIT  563 

gives  to  the  diligent  searcher  a  complete  source  of  information. 
But  the  information  contained  in  this  monumental  periodical, 
as  referred  to  elsewhere,  not  only  on  civil  loans  but  on  other 
security  issues  has  hardly  been  touched  by  the  analyst  of 
municipal  securities. 

More  emphasis  must  be  placed  on  the  history  of  national  and 
state  loans,  however,  than  on  the  history  of  the  minor  civil  divi- 
sions of  the  state.  The  nation  or  state  cannot  be  sued,  a  minor 
division  can,  and  so  even  if  a  defalcation  does  occur,  there  is 
always  recourse  to  the  courts.  And  where  benefits  have  been  en- 
joyed, the  courts  now  are  prone  to  disregard  a  theoretical  tech- 
nicality and  force  the  recipient  to  pay.  This  is  not  so  with  the 
state.  Only  another  state  has  the  right  to  sue  a  state  and  no 
national  government  can  be  sued.  The  only  security  then  of 
national  and  state  governments  is  "their  promise  to  pay." 


CHAPTER  XXXIV 

VALUATION,  TAX  RATE,  AND  VALIDITY  AS  BELATED 
TO  CIVIL  LOAN  VALUATION 

The  chief  source  of  income  for  a  state  or  any  of  its  political 
divisions  is  from  taxation.  But  before  an  understanding  of 
the  significance  of  the  tax  rate  can  be  had,  the  method  of  evalu- 
ating the  property  upon  which  the  tax  rate  is  levied  must  first 
be  known.  To  the  average  person,  with  the  exception  of  such 
investors  as  have  taken  time  to  investigate  the  financial  systems 
of  the  states,  the  assessed  valuation  of  the  property  is  the  same 
as  the  real  value.  This  is  true  in  only  a  few  instances,  and  fail- 
ure to  realize  this  fact  often  leads  to  a  mistaken  notion  of  the 
possible  income  or  the  possible  additional  increased  income 
that  would  be  available  for  the  payment  of  the  interest  and 
principal  of  the  bonds  issued  by  a  particular  political  division. 

The  term  " assessed  valuation"  as  used  in  bond  circulars 
designates  the  valuation  placed  upon  the  property  of  the  com- 
munity as  a  basis  for  taxation.  If  the  assessed  valuation  is 
made  at  the  rate  of  100  per  cent  of  the  "actual  market"  or 
"fair  cash  value,"  the  assessed  value  and  the  market  value  are 
the  same.  But  if  the  rate  of  the  assessed  valuation  to  the  actual 
market  value  is  less  than  100  per  cent,  obviously  the  assessed 
valuation  is  less  than  the  actual  market  value.  Consequently, 
unless  the  rates  of  the  assessed  valuation  to  market  value  are 
the  same,  any  comparison  of  either  assessed  valuation  or  the 
tax  rate  of  different  political  divisions  is  meaningless.  For  ex- 
ample, how  could  a  comparison  be  made  between  the  grand  tax 
list  of  Vermont  real  estate,  which  is  assessed  at  1  per  cent  of 
the  fair  market  value,1  and  Kansas2  real  estate  which  is  assessed 


^Vermont  Public  Statutes,  1906,  Section  560. 

'Financial  Statistics   of   Cities  Having   a  Population   Over  30,000 
(1917),  United  States  Bureau  of  Census,  Table  32. 

564 


VALUATION,  TAXATION,  VALIDITY  565 

at  100  per  cent  of  the  actual  market  value?  Likewise  a  com- 
parison of  the  tax  rates  levied  upon  the  assessed  valuations  of 
these  respective  states  would  be  pointless.  Despite  these  obvious 
facts,  which  it  would  seem  should  be  of  common  knowledge  to 
local  officials  of  minor  civil  divisions,  many  amusing  comparisons 
are  made  by  them. 

Although  most  states  require  that  property  shall  be  assessed 
at  a  given  rate  of  the  "fair  cash  value,"  the  methods  or  lack 
of  methods  in  administration,  entirely  destroy  the  purpose  of 
the  law.  Especially  is  this  true  where  the  local  appraisers  have 
jurisdiction  in  interpreting  the  meaning  of  the  law,  as  they 
have  in  most  states.  This  makes  variations  possible  in  the 
assessed  value  of  the  same  items  not  only  in  different  states 
but  even  in  adjoining  counties  of  the  same  state.  Corporation 
property  in  one  county  may  be  carried  at  an  exorbitant  assessed 
value  and  scarcely  be  considered  in  a  neighboring  county. 

As  wide  a  discrepancy  will  also  be  found  in  the  items  that 
can  be  taxed,  as  in  the  manner  of  assessments.  While,  for  ex- 
ample, Minnesota  and  Missouri  formerly  derived  their  revenue 
mainly  from  the  general  property  tax,  Pennsylvania,  Delaware 
and  New  Jersey  have  no  general  property  tax.  Life  insurance 
companies  in  Massachusetts  pay  one-fourth  of  one  per  cent  per 
annum  upon  the  net  value  of  all  policies  in  force ;  in  New  York 
they  pay  one  per  cent  of  gross  premiums ;  but  in  Idaho  mutual 
insurance  companies  have  no  special  insurance  tax.  A  great 
number  of  the  Southern  states  have  general  business  and  license 
taxes  that  do  not  exist  in  New  England.  Louisiana  taxes  the 
gross  receipts  of  its  railroads,  but  in  Delaware  the  tax  is  on  the 
capital  shares.  Massachusetts  taxes  savings  banks  deposits; 
Colorado  does  not.  This  wide  variation  in  the  use  or  non-use  of 
many  items  will  determine  the  elasticity  or  inelasticity  of  the 
source  of  income  for  a  state  or  any  of  its  divisions.  If  the 
most  valuable  items  that  can  be  assessed  are  already  included 
in  the  general  tax  list,  tax  expansion  is  obviously  greatly  lim- 
ited. And  for  comparative  purposes,  it  is  equally  essential  in 
determining  the  status  of  state  credit  to  ascertain  the  relative 
ratios  of  the  respective  items  that  are  or  might  be  included 
among  the  taxable  items  of  a  state. 


566  INVESTMENT  ANALYSIS 

With  the  multiplicity  of  tax  legislation,  every  tax  law  affect- 
ing a  particular  item  should  be  considered  in  relation  to  the 
entire  revenue  system.  Though  legislatures  are  now  awakening 
to  the  evil  results  of  double  taxation,  the  frequency  with  which 
it  still  exists  shows  the  necessity  of  regarding  the  relation  of 
each  individual  law  governing  the  taxation  of  a  single  item  to 
the  law  as  a  whole.  Where  this  duplication  affects  the  more 
important  items  in  the  general  assessed  tax  list,  especially 
where  the  existing  tax  is  already  large  or  the  resources  and 
wealth  are  very  much  limited,  and  the  important  taxable  items 
are  subject  to  this  condition  or  a  future  increase  in  taxation 
must  be  subject  to  this  duplication,  this  factor  should  be  given 
careful  consideration.  If  the  state  has  no  general  property  tax, 
it  is  a  potential  source  of  income  that  may  be  used  in  time  of 
financial  need. 

The  shifting  change  in  the  listing  of  personal  and  real  prop- 
erty— which  as  every  one  knows  is  absurd  and  unjust — will 
ultimately  force  a  complete  change  in  the  basis  of  taxation, 
indications  of  which  have  already  appeared.  The  establishment 
of  the  income  tax  is  an  example.  The  danger,  as  in  all  reforms, 
is  of  the  pendulum  swinging  too  far  in  the  other  direction. 

It  should  not  be  assumed  that  a  state  has  increased  in  wealth 
without  first  being  sure  that  a  large  part  of  the  increased  wealth 
is  not  due  to  a  change  in  appraisement  or  assessment.  The 
wealth  of  a  state  which  was  formerly  appraised  and  listed  at 
twenty-five  per  cent  may  now  be  appraised  at  par  value.  A 
comparison  of  the  states  which  have  increased  the  percentage  of 
their  appraisement  of  the  total  taxable  wealth  will  show  some 
remarkable  changes  in  the  last  quarter  of  a  century.  It  is  con- 
sequently always  necessary  in  any  comparative  analysis  to  de- 
termine carefully  whether  there  has  been  a  change  in  the  method 
of  appraisement. 

While  the  revaluation  and  equalization  by  commissions  or 
boards  are  generally  never  very  thorough-going,  they  at  least 
show  us  the  tendency  of  the  respective  states  and  the  conditions 
that  we  must  guard  against.  It  stands  to  reason  that  where 
revaluation  varies  from  one  year  as  in  Wisconsin  to  two  years 
in  Maine,  four  years  in  New  Hampshire,  ten  years  in  West 


VALUATION,  TAXATION,  VALIDITY  567 

Virginia,  and  sixteen  to  seventeen  in  Ehode  Island,  there  will 
be  wide  discrepancies  between  assessed  and  real  valuation.  In 
other  cases  real  property  may  be  subject  to  long  interims  be- 
tween valuations,  while  personal  property  may  be  revalued  every 
year.  But  even  where  there  are  annual  revaluations,  experience 
has  shown  that  these  valuations  are  more  often  open  to  severe 
criticism  than  otherwise,  and  it  is  only  when  an  occasional 
official  assumes  control  that  anything  like  an  accurate  valuation 
is  made.  Equalization  boards,  in  some  instances,  probably  cor- 
rect the  unjust  burden  of  certain  individuals,  associations,  or 
corporations,  but  this  has  no  appreciable  effect  on  the  revenue 
of  the  state  or  its  obligations.  The  original  statement  may  be 
revised  but,  as  H.  C.  Adams  suggests,  "the  assessments  of  spe- 
cific properties  will  remain  proportionately  to  each  other  as 
they  were  originally  handed  in."  Where  the  state  census  is 
taken  in  the  interim  of  the  national  census,  it  also  makes  pos- 
sible a  more  frequent  checking  up  of  inequitable  per  capita 
distribution  of  taxes.  If  the  state  census  also  includes  a  relist- 
ing of  all  property,  the  results  are  as  nearly  accurate  as  can 
be  expected. 

In  county,  township,  municipal  and  special  tax  districts,  the 
exclusiveness  or  inclusiveness  of  valuation  as  applied  to  any  or 
all  of  these  civil  divisions,  will  make  assessed  valuation  large  or 
small  without  any  necessary  relation  to  the  value  of  the  prop- 
erty within  the  jurisdiction.  For  illustration,  a  .comparison  of 
the  total  valuation  of  the  property  of  a  county  which  includes 
the  property  of  a  large  city  within  its  boundaries  with  that  of  a 
county  which  does  not  include  the  city's  property  in  its  own 
valuation  has  no  significance.  While  most  of  the  exclusions  or 
inclusions  of  property  in  overlapping  political  divisions  are  not 
so  marked  as  in  the  foregoing  illustration,  continual  compari- 
sons are  made  in  which  partial  existence  of  these  conditions 
destroys  the  value  of  the  comparison. 

In  these  classifications  of  property  for  assessment  purposes, 
the  city  valuations — especially  in  Maryland,  Pennsylvania,  and 
Virginia — differ  from  the  valuations  for  state  and  county  pur- 
poses. "This  difference,"  states  the  Federal  Census  Depart- 
ment, "results  largely  from  the  fact  that  certain  classes  of 


568  INVESTMENT  ANALYSIS 

property,  especially  that  of  corporations,  are  in  these  states 
subject  to  state  taxation,  but  the  valuation  of  such  property  does 
not  appear  in  the  report  of  the  property  taxed  for  city  pur- 
poses. In  some  instances  the  assessed  valuation  of  an  inde- 
pendent division  of  the  government  of  a  city,  such  as  a  school 
or  a  park  district,  differs  from  that  of  the  city  corporation. 
These  differences  are  due  to:  (1)  differences  in  the  area  of  the 
city  corporation  and  of  the  independent  division;  for  example, 
the  school  districts  of  most  Ohio  cities,  the  park  districts  of  some 
Illinois  cities,  the  sanitary  district  of  Chicago  and  the  bridge 
district  of  Portland,  Me.,  include  territory  outside  of  the  city 
limits,  while  a  few  school  districts  include  only  a  portion  of  the 
territory  within  the  cities;  or  (2)  different  basis  of  assessment, 
as  in  Dubuque,  Iowa,  where  the  city  makes  its  own  assessment 
of  property,  while  the  school  district  uses  a  totally  different 
assessment  of  the  same  property  made  by  the  county."1 

Taxation  and  the  Tax  Rate. — Whether  a  debt  is  created  by 
a  state,  county,  or  city  government,  the  funds  for  the  payment 
thereof  must  be  raised  by  means  of  the  power  of  these  respec- 
tive governments  to  tax.  As  a  very  limited  proportion  of  the 
expenditures  made  by  any  one  of  these  political  divisions  is 
devoted  to  projects  that  will  produce  revenue,  the  extent  or 
limit  of  this  power  is  the  more  important.  These  funds  are 
non-compensatory,  i.  e.,  they  are  invested  for  what  might  be 
called  the  production  of  a  social  income — public  schools  are 
maintained  to  train  the  young,  roads  are  paved  to  facilitate 
travel,  and  a  police  department  is  established  to  protect  life  and 
property.  These  all  yield  a  common  "  service-income, "  but  they 
do  not  furnish  revenue-producing  income  by  which  they  may 
sustain  themselves.  The  power  of  the  national  or  state  gov- 
ernments to  secure  this  necessary  income  by  taxation  and  their 
willingness  and  ability  to  supply  this  income  measure  the 
strength  of  their  security,  for  both  principal  and  interest  must 
be  met  by  the  income  from  taxation.  While  the  political  sub- 
divisions of  the  state  must  secure  funds  to  pay  their  debts  in 


financial  Statistics   of  Cities   Having  a  Population   Over  30,000 
(1917),  United  States  Bureau  of  Census,  p.  113. 


VALUATION,  TAXATION.  VALIDITY  569 

the  same  manner,  the  power  to  do  so  is  conferred  on  them  by 
the  state.  Hence  the  powers  and  limitations  conferred  upon 
these  divisions  by  the  state  need  special  emphasis. 

Following  all  the  ramifications  of  the  powers  and  rights  to 
tax  "is  even  more  perplexing  than  unraveling  the  regulations 
affecting  debt  obligations."  Of  these  complexities,  Professor 
H.  C.  Adams  states:  "In  applying  the  rule  that  the  power  to 
tax  'acknowledges  no  limits,'  it  is  necessary  to  distinguish  be- 
tween its  exercise  by  a  government  recognized  as  sovereign, 
even  though  it  be  within  a  restricted  jurisdiction,  and  a  gov- 
ernment which  is  the  representative  of  or  the  agent  of  a  sov- 
ereign government.  A  county,  a  township,  or  a  school  district, 
for  example,  is,  strictly  speaking,  no  government  at  all,  but  an 
administrative  unit  acting  for  a  government  for  certain  spe- 
cified ends.  This,  however,  according  to  the  theory  of  Ameri- 
can law,  must  find  expression  in  the  fundamental  law  of  the 
State  itself."1  But  it  is  not  essential  that  all  of  these  com- 
plexities be  set  forth,  even  if  all  of  the  data  were  available,  in 
order  for  one  to  understand  the  analysis  which  must  be  made  of 
a  municipal  statement. 

An  analysis  of  the  tax  rate  as  applied  to  the  security  of  a 
civil  bond  issue  must  take  into  consideration:  (a)  the  rate  in 
relation  to  valuation;  (b)  the  exclusiveness  or  inclusiveness  of 
the  rate;  (c)  the  rate  in  overlapping  jurisdictions;  (d)  the  rate 
in  relation  to  the  debt-paying  policy;  (e)  the  fixed  limit  on 
the  rate  to  be  levied;  (f)  the  levying  of  taxes  on  particular 
classes  of  property  for  particular  purposes;  and  (g)  the  con- 
trol of  the  rate  and  taxation  by  municipal  legislation. 

The  nominal  tax  rate  authorized  by  the  constitution  or 
statute  is  in  itself  meaningless  unless  it  is  known  that  it  equals 
or  is  translated  into  the  actual  rate.  Or  the  same  thing  may  be 
stated  in  this  manner;  the  ratio  of  the  actual  rate  to  the  real 
value  of  taxable  property  must  be  ascertained  before  a  compari- 
son can  be  made  of  the  tax  rates  of  two  or  more  states,  cities,  etc. 
As  stated  under  the  topic  of  Valuation,  the  ratio  of  the  assess- 
ment valuations  to  the  taxable  value  of  property  may  vary  from 
one  to  one  hundred  per  cent  of  the  market  value  of  the  tax- 


"Henry  Carter  Adams,  TJie  Science  of  Finance  (1903),  p.  307. 


570  INVESTMENT  ANALYSIS 

able  property.  It  is  necessary,  therefore,  that  a  study  of  the 
tax  rate  first  determine  these  ratios,  which  can  then  be  used  as  a 
common  denominator. 

The  exclusiveness  or  inclusiveness  of  the  tax  rate  to  more 
than  one  tax  jurisdiction  will  determine  both  the  ability  to  pay 
and  the  ability  to  increase  the  rate.  Usually  each  political  divi- 
sion has  its  own  independent  rate,  though  a  number  of  excep- 
tions exist.  For  illustration,  the  state  tax  rate  (nominal)  per 
$1,000  in  New  Hampshire  is  $16.00  and  only  .96  (cents)  in 
Ohio,  or  $10.00  in  Vermont  and  only  .90  (cents)  in  Indiana 
(1912).  An  examination  of  the  total  net  tax  in  these  respec- 
tive commonwealths  shows  very  little  difference.  The  New 
Hampshire  and  Vermont  state  rates  include  the  tax  rate  for 
both  the  state  and  other  minor  civil  divisions,  while  the  Ohio 
and  Indiana  rates  are  exclusively  state  rates.  Further,  neither 
is  the  Ohio  nor  the  Indiana  rates,  which  are  technically  known 
as  the  state  tax  rates,  the  total  that  should  be  allotted  to  the 
states.  Indiana,  for  example,  has  a  special  rate — exclusive  of 
this  rate — that  is  levied  for  the  benefit  of  benevolent  and  edu- 
cational institutions,  etc.  The  rate  for  Indiana  in  the  same 
year  for  state  purposes,  including  the  general  tax  of  .90  (cents), 
was  $4.085.  A  general  state  tax  as  low  as  .10  (cents)  per 
$1,000  (as  in  Virginia  in  1913)  might  be  levied,  but  an  exorbi- 
tant total  rate  might  also  be  levied  in  the  minor  civil  divisions 
or  by  special  taxes.  The  state  tax,  therefore,  may  be  no  indi- 
cation of  the  present  tax  burden  or  of  the  possible  increased 
demand  that  might  be  made  on  the  resources  of  the  common- 
wealth or  its  subdivisions  in  case  of  an  emergency. 

There  is  a  seemingly  growing  tendency  at  the  present  time 
in  favor  of  separating  state  and  local  taxation,  and  designating 
certain  properties  that  shall  be  taxed  only  for  state  purposes. 
Few  states,  however,  have  as  yet  adopted  the  policy  of  Cali- 
fornia, which  by  an  amendment  of  the  Constitution  (1910), 
provides  that  public  service  corporations,  banks,  and  insurance 
companies  shall  be  taxed  for  state  purposes  and  exempts  "the 
operative  property  of  these  companies  from  local  taxation  by 
counties,  cities,  towns  and  districts,  except  for  the  payment  of 
principal  and  interest  on  indebtedness  existing  before  Novem- 


VALUATION,  TAXATION,  VALIDITY  571 

her  8,  1910."  The  counties  depend  on  the  general  property  and 
license  taxes.  Connecticut  and  New  Jersey,  with  the  exception 
of  the  school  tax,  have  an  almost  entire  separation  of  state  and 
local  government  for  state  purposes.  Delaware  derives  its 
revenues  from  corporation  and  inheritance  taxes  and  licenses 
on  various  companies,  but  levies  no  general  property  tax. 
Maryland  leaves  all  railroad  property  to  be  taxed  by  local  gov- 
ernments. Though  a  number  of  states,  as  Minnesota,  derive 
an  increasing  amount  of  their  taxes  from  special  or  certain 
stipulated  items,  the  entire  separation  of  state  and  local  taxes 
has  not  been  accomplished. 

All  taxes,  however,  do  not  lend  themselves  with  equal  ad- 
vantage to  revenue  purposes.  In  studying  the  problem  of  a 
possible  increase  in  taxes  from  new  sources,  the  amount  and  the 
policy  of  handling  the  current  and  contingent  debts  must  be 
considered.  This  particularly  applies  to  civil  units  within  the 
state.  An  effective  limitation  upon  the  kinds  of  property 
which  can  be  taxed  will  also  prove  an  indirect,  though  valuable 
check  on  the  amount  of  debt  which  can  be  assumed. 

Particular  care  must  be  exercised  in  the  study  and  com- 
parison of  the  county,  township,  city,  town,  and  special  tax 
district  tax  rates,  as  was  suggested  in  the  study  of  property 
valuation  of  a  particular  division.  Bond  circulars  are  particu- 
larly deficient  in  making  accurate  distinction  between  the  rate 
of  taxation  paid  to  a  particular  jurisdiction  by  its  inhabitants, 
and  the  total  tax  including  all  the  tax  rates  applied  to  the  resi- 
dents of  this  same  jurisdiction.  Different  rates  may  even  exist 
within  the  municipality's  own  jurisdiction,  as  is  the  case  in 
some  of  the  cities  of  the  state  of  Washington. 

The  existing  rate  of  the  tax  and  the  total  amount  of  taxes 
paid  must  be  examined  in*  light  of  the  debt  paying  policy  of 
the  issuing  unit  as  well  as  the  policies  of  all  other  units  to  which 
the  tax-payer  is  subject.  A  civil  corporation  may  adopt  the 
policy  of  the  early  extinguishment  of  both  funded  and  contin- 
gent debt,  and  thus  the  rate  will  be  made  exceptionally  high  for 
a  short  period.  A  comparison  of  the  tax  rates  and  the  amount 
of  indebtedness  for  a  period  will  disclose  any  such  existing 
policy.  On  the  other  hand,  control  of  the  state  or  municipal 


572  INVESTMENT  ANALYSIS 

tax  rate  through  a  limit  on  the  tax  rate,  as  in  Georgia  for  state 
purposes  and  West  Virginia  for  counties,  is  neither  the  most 
effective  nor  fundamental  method  of  control.  Massachusetts1 
while  it  has  very  carefully  limited  the  amount  of  its  indebt- 
ness  has  no  tax  limit.2  Any  great  increase  in  the  tax  rate  will 
in  itself  cause  public  opposition  and  thus  automatically  check 
the  increase.  Fortunately  this  form  of  control  or  limitation 
is  not  a  very  common  one.  If  the  limit  applies  for  both  funded 
and  current  indebtedness,  it  is  especially  dangerous,  as  it  fre- 
quently tempts  the  municipal  official  under  the  pressure  of 
large  current  debts  to  use  devices  to  evade  this  limitation. 

Nearly  one-third  of  the  states,  as  for  example  California 
and  Iowa,  require  that  when  a  county,  city,  or  other  civil  divi- 
sion makes  a  bond  issue,  provision  shall  be  made  for  the  levy- 
ing of  a  tax  at  the  time  of  issuing,  to  pay  the  interest  payments 
and  the  principal  when  due.  The  safety  of  the  bond  is  not  then 
endangered  by  a  cut  into  the  general  revenues  for  other  pur- 
poses or  the  reduction  of  income  by  manipulation  of  the  valua- 
tion of  assets.  The  bond  enabling  acts,  however,  provide  for 
the  levying  of  taxes,  and  they  are  given  complete  cognizance 
in  all  courts.  And  as  long  as  this  power  exists  in  these  acts, 
there  is  little  fear  that  the  courts  will  not  enforce  payment. 

Any  very  wide  latitude  in  the  increase  of  tax  rates  by  a 
municipality  is  open  to  serious  objections.  The  ease  with  which 
such  legislation  can  be  tampered  with  by  politicians  is  alone 
sufficient  reason  for  not  placing  too  much  emphasis  upon  this 
control.  When  the  demand  arises,  legislation  is  usually  forced 
through  the  city  or  town  councils  with  little  hesitancy  and 
any  existing  legislation  prohibiting  future  increase  in  rates  is 
soon  repealed. 

Creation  of  the  Special  Tax  District. — The  Special  Tax  Dis- 
trict is  a  voluntary  quasi-municipal  corporation  created  by  the 
residents  of  a  given  geographical  area  who  desire  to  secure 
certain  improvements  for  this  area.'  These  improvements  are 


'See  Massachusetts  Statutes  for  1913,  chap.  719,  Sec.  12. 

2For  an  interesting  case  in  this  connection,  see  United  States  vs. 
Clark  County,  96  U.  S.  211 ;  also  Supervisor  vs.  U.  S.,  IS  Wall  71. 

"From  a  strictly  legal  point  of  view,  these  bonds  cannot  be  included 
in  the  general  classification  of  municipals. 


VALUATION,  TAXATION,  VALIDITY  573 

financed  through  bond  issues  which  are  made  claims  against  the 
property  within  the  area.  This  indebtedness,  in  turn,  is  met 
by  a  tax  levied  upon  the  taxpayers  of  this  same  district.  Even 
where  the  state  at  large  may  benefit,  as  in  harbor  improvements, 
the  taxpayers  within  the  district  who  have  assumed  the  debt 
must  pay  it.1 

The  detailed  statutory  requirements  and  scope  of  these  dis- 
tricts vary  with  the  different  states.  The  important  considera- 
tions in  the  creation  of  these  districts  are:  the  purposes;  the 
extent  of  the  district;  and  the  powers  and  limitations  in  the 
creation  and  payment  of  the  debt  as  authorized  by  the  state 
constitutions  or  statutes.  Unless  restricted  by  the  constitution 
or  statutes,  the  taxpayers  of  a  given  area  can  organize  for 
almost  any  purpose  to  issue  loans  for  common  public  benefits 
of  a  district.  Most  commonly  these  organizations  are  for 
drainage,  levee,  irrigation,  harbor  improvements,  sanitation, 
fire,  power,  water,  road  and  school  purposes.  During  the  period 
from  1870  to  1890  a  great  many  special  assessment  tax  districts 
were  organized  for  the  purpose  of  issuing  bonds  to  aid  rail- 
road construction  in  a  particular  locality.  The  history  of  this 
period  furnishes  some  of  the  most  unsavory  of  municipal  bond 
repudiations. 

The  geographical  boundaries  of  these  special  tax  districts 
may  coincide  with  an  existing  political  division,  such  as  the 
city  or  township,  or  they  may  include  two  or  more  municipali- 
ties, or  they  may  be  only  a  part  of  an  existing  political  unit. 
Of  the  first  type,  the  school  district  of  the  Middle  Western 
states,  which  commonly  coincides  with  the  political  jurisdiction 
of  the  township,  is  a  good  example.  But  the  school  districts 
in  cities  and  towns  of  these  same  states  may  include  only  a 
part  of  the  city  and  two  or  more  districts  may  be  organized 
within  the  city  limits.  Drainage,  levee,  and  irrigation  districts 
will  not  infrequently  include  several  counties.  The  Sanitary 
District  of  Chicago,  the  most  important  in  the  county,  includes 
a  considerable  area  outside  the  city  limits.  The  water  districts 
of  Maine,  where  towns  are  closely  situated  and  can  use  the 

'Mobile  vs.  Kimball,  102   TL  S.  691,  Ic  703  L.  Ed.  238 ;  Davidson  vs. 
New  Orleans,  96   U.  S.  97;  Louisiana  vs.  Pillsbury,  105   U.  S.  278,  295. 


574  INVESTMENT  ANALYSIS 

same  water  supply,  include  two  or  more  towns.  No  common 
standard  for  the  size  or  importance  of  these  tax-districts  can 
be  said  to  exist  for  the  United  States  at  large.  While  a  suffi- 
cient number  of  taxpayers  are  always  necessary  to  insure  the 
establishment  of  a  district,  the  costs  of  financing  a  project  vary 
so  much  that  no  comparison  can  be  made.  A  small  well-popu- 
lated area  desiring  to  build  a  more  effective  drainage  system 
might  secure  it  at  a  very  small  cost  if  topographical  conditions 
were  favorable.  "Whereas  the  inhabitants  of  an  area  covering 
several  townships,  with  difficult  drainage  problems,  if  they 
desired  to  do  the  same  thing,  would  find  that  it  involved  a 
heavy  tax.  The  same  would  be  particularly  true  of  levee  and 
irrigation  districts.  On  the  other  hand,  school,  fire,  power  and 
water  districts  would  be  more  dependent  upon  the  character 
and  number  of  the  population  than  upon  any  other  factor.  The 
exclusiveness  or  inclusiveness  of  the  size  of  the  areas  will,  con- 
sequently, often  be  the  determinant  in  evaluating  the  bond. 
This  again  recalls  the  distinction  previously  made  between  rural 
and  urban  communities,  and  even  where  the  district  is  outside 
of  the  city  limits,  its  adjacency  to  a  city  will  increase  the 
value  of  the  security.  A  comparison  of  the  value  of  the  prop- 
erty of  a  special  tax  district  with  the  assessed  valuation  of  the 
political  division  or  divisions  of  which  it  is  a  part,  will  reveal 
whether  it  is  an  urban  or  rural  district  or  whether  it  is  only  a 
part  or  coincides  with  the  unit.  As  the  assessment  of  the  prop- 
erty of  the  special  tax  district  is  not  made  independently,  the 
method  and  shortcomings  of  American  assessments  already 
treated,  apply  equally  well  to  special  tax  districts.  The  debt 
of  the  special  tax  district  has  also  been  referred  to  under  the 
general  topic  of  debt. 

The  very  advantage  which  the  privilege  of  organizing  a 
special  tax  district  conveys  to  a  community,  is  at  the  same  time 
a  source  of  weakness.  A  rural  community,  sparsely  populated 
and  with  considerable  area  of  poor  territory,  may  organize, 
make  a  bond  issue,  and  tax  itself  with  the  equal  privilege  of  a 
great  metropolitan  district.  These  conditions  make  the  issues 
of  the  special  tax  districts  the  most  complex  and  the  most  diffi- 


VALUATION,  TAXATION,  VALIDITY  575 

cult  to  evaluate.  Under  the  influence  of  a  wave  of  popularity 
certain  improvements  are  desired  and  a  special  district  is  organ- 
ized, but  the  improvements  fail  to  fulfill  all  anticipations.  De- 
crease in  market  value  of  property  usually  results  and  tax 
burdens  are  increased  with  a  corresponding  decrease  in  the  value 
of  the  security.  Also  the  weakness  of  the  special  tax  district  as 
a  civil  administrative  unit  and  its  limited  jurisdiction,  necessi- 
tate a  more  careful  analysis  of  these  securities  than  of  other 
civil  obligations. 

Legality  and  Validity. — Legality  and  validity  are  not  neces- 
sarily synonymous  terms,  as  is  commonly  believed.  A  bond 
illegally  issued  may  sometimes  be  made  valid  by  a  court  deci- 
sion. And  as  stated  elsewhere,  the  tendency  of  court  decisions 
where  illegal  bonds  have  fallen  into  innocent  hands  is  to  hold 
the  bonds  as  a  valid  issue. 

Thirty  years  ago  the  question  of  the  legality  of  a  civil 
bond  issue  would  have  been  the  most  important  single  consid- 
eration with  which  the  purchaser  of  civil  obligations  would  have 
been  confronted.  While  the  necessity  for  a  consideration  of 
their  legality  still  continues,  the  likelihood  of  default  due  to 
the  illegality  of  issue  is  indeed  small.  This  is  evidenced  by  the 
small  number  of  repudiations  which  have  occurred  since  1900. 
A  great  deal  has  been  written  and  much  emphasis  placed  upon 
the  repudiation  of  state  and  other  civil  issues,  though  an  exam- 
ination of  the  lists  of  these  repudiations  shows  that  they 
occurred  prior  to  this  date.  Better  formulated  statutes,  more 
complete  and  wider  range  of  judicial  decisions,  and  well  stand- 
ardized legal  codifications  have  enabled  the  municipal  bond 
attorneys  to  detect  any  legal  flaws  in  an  issue.1  Also  the  cer- 
tification of  genuineness  by  a  trust  company,  while  not  a  guar- 
antee, adds  another  safeguard.  This  is  further  insured  by  the 
attitude  which  the  courts  are  now  taking  in  cases  where  the 
funds  have  been  appropriated  and  used.  Where  no  obstacle 
has  been  placed  in  the  way  of  the  issuing  civil  corporation, 

1PThis  would  not  apply  to  some  of  the  old  bonds  of  the  Recon- 
struction Period  which  still  occasionally  appear.  It  need  only  be 
reiterated  here  that  the  instrument  purchased  should  always  be  scru- 
tinized. 


576  INVESTMENT  ANALYSIS 

even  though  its  issuance  has  not  conformed  in  all  details  to 
legal  procedure,  it  is  now  held  accountable,  but  there  is  little 
chance  of  any  contest  where  the  issue  has  been  passed  upon 
by  expert  counsel. 

Where  either  national  or  state  bonds  are  concerned,  even  a 
Supreme  Court  decision  of  legality  could  not  force  payment 
to  the  bondholder,  if  the  Federal  or  state  government  wills  to 
repudiate  it.  When  state  bond  issues  have  been  repudiated  the 
defense  has  always  been  that  they  were  illegally  issued.  Every 
bond  man  knows,  however,  that  the  real  reason  was  inability 
to  pay.  Authentic  legality  leaves  no  grounds  for  the  state  to 
refuse  payment  except  through  repudiation.  The  latter  is  today 
highly  improbable,  especially  considering  the  care  with  which 
such  issues  are  scrutinized  by  the  bond  attorney. 

The  purposes  for  which  county  bonds  can  be  issued  .are  so 
narrowly  defined  that  the  purchaser  needs  to  examine  these 
certificates  more  carefully  in  relation  to  purposes  of  issue  than 
any  of  the  other  municipal  issues  except  special  assessment 
bonds.  The  purposes  for  which  these  bonds  may  be  issued,  as 
designated  in  the  Federal  census,  are  to  build  courthouses,  other 
buildings  (school  houses,  asylums,  etc.),  roads  and  bridges,  and 
railroad  subsidies.  The  miscellaneous  and  unspecified  items  in 
county  indebtedness  are  the  items  referred  to  above  concern- 
ing which  the  legality  of  issues  has  been  the  chief  source  of 
trouble.  The  items  of  funding  and  refunding  bonds  in  county 
issues,  do  not  need  the  emphasis  so  much  on  the  legality  of  the 
refunding  issues  themselves  as  upon  the  legality  of  the  issues 
which  they  replace. 

As  all  powers  are  delegated  to  the  minor  civil  divisions  of 
the  state,  the  danger  of  the  violation  of  technical  requirements 
is  increased.  The  Federal  Court  states :  "  A  county  is  an  organ- 
ized political  subdivision  of  the  state.  It  has  such  power,  and 
such  only,  to  contract  loans  and  to  incur  other  forms  of  indebt- 
edness as  is  expressly  or  by  fair  implication  granted  to  it  by 
the  legislature  of  the  state  .  .  .  "l  "The  full  legal  deter- 


vs.    Board    of   Commissioners   of   Lake   County,    Colo.,    26 
C.  C.  A.  32,  SO  Fed.  672. 


VALUATION,  TAXATION,  VALIDITY  577 

mination  of  a  number  of  the  minor  civil  divisions  of  the  state 
is  still  problematic  and  it  should  be  carefully  ascertained 
whether  the  territorial  unit  has  been  created  with  no  express 
plan  of  territorial  powers."  If  the  civil  division  has  no  power 
to  create  independent  contracts,  any  obligations  assumed  will 
have  no  legal  authorization.2  This  situation  of  the  non-existence 
of  a  civil  unit  must  not  be  confused  with  the  civil  unit  which 
goes  beyond  its  powers  in  issuing  a  bond,  and  may  have  suit 
brought  against  it  by  a  taxpayer  for  the  annullment  of  the 
debt.  Under  the  latter  condition  where  full  benefits  have  been 
received,  the  court  will  now  probably  hold  the  issuing  juris- 
diction liable.3 

When  one  stops  to  consider  the  multiplicity  of  these  civil 
corporations,  ranging  from  small  villages  of  two  or  three  hun- 
dred up  to  the  municipalities  which  number  their  inhabitants 
in  seven  figures,  and  the  system  under  which  American  cities 
are  governed,  the  possibility  of  legal  entanglements  is  easily 
understood.  The  wonder  is  that  there  are  not  more  incompe- 
tent officials  placed  in  charge  of  the  municipal  finances  of  our 
towns  and  cities  by  popular  vote.  They  are  very  seldom 
elected  to  office  because  of  their  understanding  of  municipal 
financial  affairs  and  problems.  The  mistakes  of  ignorant  and 
incompetent  officials  from  which  every  municipality  has  at  some 
time  or  other  suffered,  are  such  common  knowledge  that  they 
need  no  detailed  statement  here.  Too  frequently  these  mis- 
takes are  never  brought  to  the  attention  of  the  general  public. 
How  many  readers  even  of  these  pages  have  ever  carefully 
perused  the  financial  statement  of  their  own  city?  It  is  for- 
tunate, then,  that  we  are  able  today  to  place  so  much  depend- 
ence upon  an  expert  municipal  bond  attorney's  rulings  as  to 
the  validity  of  municipal  issues. 

All  authority  for  the  issuance  of  bonds  by  civil  corpora- 
tions is  conferred  by  either  constitution  or  statutes  or  both. 


JFolsom  vs.  Township  Ninety-six,  159  TJ.  S.  611,  16  Sup.  Ct.  Rep. 
174,  40  L.  Ed.  278. 

"Harshman  vs.  Bates  County,  92  U.  S.  569,  23  L.  Ed.  747 ;  Board  of 
Trustees  vs.  Battleboro  Savings  Bank,  106  Fed.  986,  46  C.  C.  A.  66. 

'Speer  vs.  Board  of  County  Commissioners  of  Kearney  County, 
Kan.,  88  Fed.  749. 


578  INVESTMENT  ANALYSIS 

Without  this  authority  the  bonds  are  void.  Certainly  issues 
made  under  a  special  legislative  act  should  be  avoided,  as  the 
courts  are  at  variance  in  their  decisions  of  these  cases.  Even 
the  right  to  undertake  a  project  might  be  authorized,  and  the 
civil  corporation  allowed  to  raise  taxes  without  having  the  right 
to  contract  a  debt.1  If  the  right  to  assume  an  indebtedness 
is  only  implied  "when  its  exercise  is  incident  and  neces- 
sary to  the  exercise  and  enjoyment  of  powers  that  have  been 
expressly  granted,  the  bonds  issued  under  this  power  may  have 
a  basis  of  authoritative  issue.  Further,  the  court  decisions  in 
the  interpretation  of  the  implied  powers  of  the  enabling  stat- 
utes have  not  always  been  in  perfect  accord."  Since  statutes 
affecting  bond  issues  have  been  passed  at  varying  intervals  and 
often  included  in  certain  general  legislation,  it  is  difficult  for 
anyone  but  an  expert  to  be  certain  that  he  has  examined  all 
statutes  affecting  the  bond  issue.  But  as  so  often  stated,  even 
where  the  bonds  have  not  always  complied  with  all  of  the  tech- 
nicalities of  the  requirements  of  issue  but  the  benefits  have 
been  accepted  by  the  civil  corporation,  the  courts  have  usually 
held  the  issue  legal.3  A  brief  examination  of  the  court  cases 
involving  a  violation  of  the  authority  to  issue,  indicates  that 
the  great  majority  of  the  violations  have  been  issuances  for 
projects  not  within  the  province  of  the  issuing  civil  corporation. 
"Where  the  powers  of  overlapping  jurisdictions  are  not  clearly 
denned,  this  confusion  is  especially  likely  to  arise. 

No  specific  classification  or  catalogue  can  be  made  of  the 
causes  of  violation  of  authority  because  of  the  wide  difference 
in  the  powers  granted  by  constitutions.  The  general  classifica- 
tion of  violations  of  authority,  under  which  head  the  major 
part  of  the  court  cases  come,  includes:  lack  of  compliance  to 
constitutional  and  statutory  limitations ;  the  exercise  of  assumed 
legal  powers  by  "  de  facto ' '  officers  or  governing  bodies ;  unwar- 
ranted or  irregular  assumption  of  power;  issuance  without  any 
power  and  usurpation  of  authority. 


^shuelot  National  Bank  of  Keene  vs.  School  District  No.  7,  Valley 
County,  5  C.  C.  A.  468,  56  Fed.  197. 

"Chaffe  County  vs.  Potter,  142  U.  S.  355,  12  Sup.  Ct.  "Rep.  216, 
City  of  Joliet  et  al  vs.  Alexander,  194  111.  457.  62  N.  E.  861. 


VALUATION,  TAXATION,  VALIDITY  579 

Many  states  also  require  that  not  only  the  original  bond 
issue,  but  the  provision  for  the  payment  thereof  shall  be  voted 
upon  by  the  taxpayers  of  the  municipality  before  the  officials 
can  authorize  the  bond  issue.  Though  the  two  powers  of  issu- 
ance and  payment  are  usually  coextensive,  it  is  wise  to  ascer- 
tain for  a  certainty  that  this  is  true  of  any  particular  security. 
But  in  the  voters'  authorization  of  the  issue,  the  detailed  and 
technical  requirements  of  procedure  often  are  violated  because 
of  the  ignorance  of  the  corporation's  officials.  For  illustration, 
a  few  years  ago  a  Pennsylvania  village  which  had  defeated  a 
certain  bond  issue  voted  upon  it  a  second  time  and  approved  it. 
The  municipal  bond  attorneys  found  that  before  another  vote 
could  be  legally  taken  upon  an  issue  once  rejected  by  the  voters, 
one  complete  year  had  to  elapse.  The  village  voted  one  day 
too  soon  and  as  a  result  the  issue  was  rejected  by  the  banking 
house  to  whom  the  original  bid  was  awarded.  But  the  bank  as 
in  all  bids  had  made  it  a  condition  that  all  legal  requirements 
be  met  by  the  municipality.  This  may  seem  to  many  laymen 
like  "splitting  hairs,"  yet  on  the  other  hand  it  does  indicate 
the  careful  protection  given  to  the  purchasers  of  municipal 
bonds  by  banking  houses1  of  high  reputation. 

Public  corporate  bodies  and  officers  are  continually  violating 
the  debt  limits  of  their  civil  jurisdiction  until  checked  by  a 
bond  attorney.  Since  the  majority  of  these  violations  never 
come  to  the  notice  of  the  general  public,  little  appreciation  is 
had  of  this  particular  service.  Not  only  the  ignorance  of  public 
officials  regarding  the  law,  but  the  differences  in  legal  opinion 
as  to  what  should  be  included  in  net  debt,  contribute  to  the  diffi- 
culties of  this  problem. 

The  small  details  and  technical  requirements  involved  in  the 
issuance  of  civil  bonds  are  more  often  the  cause  of  the  in- 
validity of  an  issue  than  is  any  wilful  act.  The  constant  shift- 
ing of  both  public  officials  and  the  office  staffs  places  indi- 
viduals in  charge  who  are  inexperienced  and  unable  to  handle 
the  duties  correctly.  This  is  illustrated  by  the  fact  that  where 
rejections  are  made  because  of  matters  of  minor  detail  in 


'See  chap,  xxxv,  the  Debt  of  the  Civil  Division. 


580  INVESTMENT  ANALYSIS 

issue,  they  are  errors  of  omission.  This,  of  course,  is  not  true 
of  the  larger  and  more  important  legal  considerations.  As  one 
prominent  specialist  in  municipal  bonds  stated:  "However,  it 
is  really  remarkable,  in  view  of  the  constant  shifting  of  public 
officials,  and  the  fact  that  many  times  they  are  uneducated  and 
under  political  influence,  how  few  mistakes  creep  into  the  issu- 
ance of  municipal  bonds  and  defeat  their  payment.  I  want  to 
pay  tribute  to  the  average  public  official  and  say  that  so  far  as 
his  dealings  with  us  are  concerned,  he  is  more  than  99  per  cent 
honest." 

The  errors  of  issuance  are  varied.  They  cover,  for  example, 
insufficient  notice  of  election  to  qualified  voters.  The  law  usually 
provides  the  length  of  time  for  such  advertisement,  the  method, 
the  location  of  polling  places,  etc.  These  same  errors  occur  in 
the  notices  of  meetings  of  governing  bodies,  city  councils,  etc., 
held  for  the  purpose  of  adopting  ordinances  relative  to  the 
issuance  of  bonded  indebtedness.  The  failure  to  state  the  rate 
of  interest  in  the  motion  of  the  issuing  body  or  the  omission  of 
the  rate  in  subsequent  documents,  as  well  as,  the  granting  of  a 
higher  rate  than  allowed  by  the  constitution  or  statute,  have 
been  held  as  sufficient  reason  for  invalidation.  Errors  in  voting 
on  such  points  as :  time,  manner,  majorities  required  in  the  orig- 
inal corporate  body,  etc.,  are  likely  to  be  more  elusive  in  that 
they  are  apt  to  develop  through  "piece-meal"  legislation  and 
consequently  are  more  difficult  to  check.  Another  error,  though 
one  much  less  commonly  found,  is  the  failure  to  comply  with  the 
requirement  of  the  price  where  the  minimum  price,  usually  par, 
is  fixed  by  statute. 

The  issuance  of  bonds  by  a  minor  political  division  for  a 
purpose  not  within  its  jurisdiction  has  been  the  cause  of  a  con- 
siderable number  of  defaults  in  the  past.  Powers  of  issue 
recognized  in  some  states  are  either  not  recognized  or  are  pro- 
hibited in  others.  The  divergence  can  usually  be  based  upon 
what  can  be  called  private  as  distinct  from  public  purposes. 
In  some  states  the  constitution  has  been  broadly  enough  inter- 
preted to  include  many  objects  under  the  heading  of  public 
benefits.  And  still  other  agencies  which  contribute  to  public 
convenience  have  been  accepted  as  legitimate  purposes  for  which 


VALUATION,  TAXATION,  VALIDITY  581 

minor  civil  divisions  can  authoritatively  issue  bonds  when  not 
prohibited  by  the  state  constitution.  In  all  such  cases  which 
do  not  come  under  the  direct  and  explicit  powers  granted  by 
the  constitution,  the  surest  test  of  their  safety  is  a  court's  deci- 
sion. "To  the  general  proposition  that  municipal  bonds,  to  be 
valid,  must  have  been  issued  for  an  authorized  public  purpose, 
there  is  an  exception  based  upon  the  rule  of  equitable  estoppel. 
Though  the  enabling  statutes  authorize  the  issuance  of  bonds 
for  legitimate  public  purposes  only,  a  municipality  issuing  its 
negotiable  bonds  purporting  to  be  for  authorized  purpose,  but, 
in  fact  for  an  unauthorized  purpose  .  .  .  may  be  estopped 
from  denying  their  legality  after  the  securities  have  passed  into 
the  hands  of  bona  fide  holders  for  value."  As  this  latter  con- 
dition must  result  in  a  test  of  the  legitimacy  of  the  issue,  the 
investor  is  not  warranted  in  the  purchasing  of  such  securities 
until  the  test  has  actually  been  made.  As  long  as  the  purpose 
of  the  issue  is  for  the  public  welfare  and  not  a  violation  of 
the  constitution,  or  privileges  of  the  state,  it  will  stand  the  test 
of  validity.  For  assurance  that  this  is  the  situation  in  any  par- 
ticular case  we  are  dependent  upon  the  experienced  municipal 
bond  attorney." 


JW.  H.  Harris,  The  Law  Governing  the  Issuing,  Transfer  and  Col- 
lection of  Municipal  Bonds  (1917),  chap.  iv. 

2For  issues  which  were  prohibited,  the  following  are  interesting: 
Dodge  vs.  Mission  Tp.,  Shawnee  County,  Kan.  107  Fed.  827,  46  C.  C.  A. ; 
Etna  Life  Ins.  Co.  vs.  Pleasant  Township,  10  C.  C.  A.,  62  Fed.  718; 
Cole  &  La  Grange,  113  U.  S.,  5  Sup.  Ct.  Rep.  416,  28  L.  Ed.  896. 


;  CHAPTER  XXXV 

THE  DEBT  OF  THE  CIVIL  DIVISION 

Tine  Funded  Debt. — One  of  the  first  questions  raised  by  the 
investor  concerning  civil  loans  is:  "What  is  the  amount  of  the 
total  debt?"  The  debt  of  any  civil  division  must  be  viewed  in 
relation  to,  first,  the  wealth  possessed  and  ability  to  pay ;  second, 
past  practices  both  in  the  amount  of  debt  carried  and  the  punc- 
tuality of  payments;  and  third,  the  guarantee  or  assurance  in- 
directly expressed  in  the  amount  of  the  existing  debt.  It  must 
not  be  forgotten,  however,  that  the  gross  amount  of  indebted- 
ness is  only  relative  to  the  wealth  possessed  and  the  ability  to 
pay.  For  illustration,  the  resources  in  counties  of  a  similar 
area  and  wealth  may  be  in  the  process  of  active  development  in 
the  one,  but  not  in  the  other.  Or  the  limited  resources  of  a 
county  may  limit  its  possible  development.  This  has  been  fully 
discussed  in  the  two  previous  chapters. 

Until  the  European  war,  neither  the  national  nor  state  gov- 
ernments of  the  United  States  had  any  considerable  debt  out- 
standing. Our  Federal  government  has  been  the  only  western 
nation  which  has  made  any  real  attempt  to  pay  off  its  funded 
debt.  At  the  outbreak  of  the  European  War  the  funded  debt  of 
the  United  States  amounted  to  approximately  one  billion  dol- 
lars or  $10.50  per  capita,  while  the  lowest  of  any  European 
country  was  $28.45  per  capita  in  Eussia  and  the  highest  $159.87 
per  capita  in  France. 

With  probably  the  exception  of  six  or  eight  states  the  total 
amount  of  the  state  debt  is  still  relatively  small.  Kigid  restric- 
tions as  to  the  assumption  of  state  debt  have  been  somewhat 
responsible  for  this,  though  the  larger  influence  has  been  the 
popular  disfavor  with  which  the  increase  in  state  debt  is  viewed. 
The  opposition  to  large  state  indebtedness  is  an  inheritance  of 
the  panic  of  1837  and  the  constitutional  restrictions  adopted 

582 


CIVIL  DEBT  583 

from  1840  to  1850.  Under  Southern  leadership  after  the  "War 
of  1812  such  opposition  was  raised  against  Federal  improve- 
ments that  the  states  were  forced  to  assume  the  financial  re- 
sponsibility of  internal  improvements.  "With  the  payment  of 
the  Federal  debt,  the  disbursement  of  the  Federal  surplus  to 
the  states,  the  removal  of  the  deposits  from  the  Federal  to 
the  state  banks,  the  growth  of  population,  etc.,  the  states  over- 
developed internal  improvements.  The  result  was  the  whole- 
sale failure  of  these  developments  and  the  crisis  of  1837-38. 
The  stringency  and  defalcations  growing  out  of  this  failure  of 
internal  improvements  brought  a  very  strong  demand  for  debt 
limitations  and  restrictions.  Though  debt  repudiations  did  not 
cease  till  the  final  extinction  of  the  ''carpet-bag"  governments, 
the  check  to  large  state  debts  was  decisive  and  for  the  last  half 
century  state  issues  have  played  a  very  minor  role.  But  will 
state  debts  continue  on  the  decrease  while  the  debts  of  munici- 
palities increase? 

The  assertion  that  state  expenditures  will  tend  to  decrease 
as  compared  to  the  growth  of  municipal  expenditures  is  based 
on  the  actual  decrease  of  the  state  per  capita  debt  since  1890. 
But  the  functions  that  the  states  are  again  beginning  to  assume 
are  increasing  their  indebtedness  for  permanent  improvements. 
The  experience  of  the  "Western  states  in  the  last  twenty  years 
would  seem  to  warrant  this  assumption.  For  illustration,  state 
expenditures  in  1902  were  $186,000,000;  today  they  are  nearly 
$500,000,000,  though  allowance  must  be  made  for  increased  costs. 

Beginning  with  1885  the  expenditures,  especially  of  "Western 
states,  have  been  increased  with  the  development  of  the  public 
schools,  state  universities,  and  institutions  for  the  care  of 
delinquents  and  defectives,  and  departments  of  health,  educa- 
tion, labor,  railways,  public  utilities,  etc.  The  increase  of  the 
sentiment  against  large  state  indebtedness  is  still  very  strong. 
However,  it  will  not  be  large  during  the  next  decade,  though  it 
is  decidedly  on  the  increase.  Consequently  state  indebtedness 
is  not  yet  a  relatively  large  factor  or  influence  in  the  general 
investment  market.  This  small  amount  of  indebtedness,  if 
present  tendencies  continue,  is  certain  to  be  greatly  increased. 
The  condition  of  state  indebtedness  is  emphasized  by  the  fact 


584  INVESTMENT  ANALYSIS 

that  sixteen  states  have  practically  no  bonded  debt  outstanding. 
Six  states  have  no  funded  debt  of  any  kind  excepting  where  the 
owners  of  small  amounts  past  due  cannot  be  found.  Three 
states  have  no  outstanding  debt,  if  we  exclude  the  old  obliga- 
tions that  are  not  recognized  by  these  states.  The  funded  debt 
of  eight  states  is  not  held  by  the  public  but  by  the  departments 
in  the  state.1  Kentucky  might  be  considered  by  some  to  have  a 
funded  debt,  but,  "The  educational  bonds  are  not,  strictly 
speaking,  a  debt  of  the  state.  They  are  irredeemable ;  the  fund 
is  inviolate  .  .  .  interest  drawn  by  them  is  provided  for  out 
of  the  revenue  placed  to  the  credit  of  the  sinking  fund  annu- 
ally." Michigan  also  might  be  put  in  the  third  class  as  the  so- 
called  state  trust  fund  is  considered  a  misnomer  since  the 
interest  paid  on  this  fund  for  educational  purposes  is  raised  by 
taxation.  This,  of  course,  does  not  mean  that  these  states  are 
free  from  all  indebtedness,  for  some  of  them  have  a  large 
floating  debt. 

The  lack  of  uniformity  in  the  powers  of  the  political  divi- 
sions of  the  states  makes  any  general  comparison  of  financial 
data  much  more  difficult  than  that  of  the  states.  This  is  par- 
ticularly true  of  county  debts,  and  any  comparison  of  county 
debts,  must  be  based  upon  the  exclusiveness  or  inclusiveness 
of  the  debt  creating  power  of  the  political  division  within  the 
county's  boundaries.  This  latter  topic  is  discussed  at  greater 
length  under  Keal  and  Net  Debt. 

The  increase  in  the  funded  debt  of  city  governments  has 
been  more  phenomenal  than  that  of  any  other  civil  division 
having  the  power  to  create  debt.  The  very  fact,  however,  that 
the  functions  which  a  city  fulfills  for  the  community  are  numer- 
ous in  comparison  with  those  of  the  other  divisions  of  a  state 
would  be  sufficient  to  account  for  a  large  part  of  this  debt.  But 
in  the  last  quarter  of  a  century,  there  has  been  a  very  large 
expansion  in  the  duties  which  every  department  of  a  city  has 
had  to  assume  in  providing  for  the  needs  of  its  people.  In  some 


irThe  most  recent  current  check  upon  these  states  can  be  easily  se- 
cured in  the  State  and  City  Supplement  of  the  Commercial  and  Financial 
Chronicle.  With  the  change  and  increase  in  state  financing,  changes  are 
now  taking  place  in  the  attitude  of  states  toward  assuming  funded  debt. 


CIVIL  DEBT  585 

instances  cities  have  secured  special  legislative  relief  authorizing 
special  class  bonds  for  the  purchase  or  development  of  muni- 
cipally owned  and  operated  utilities  or  similarly  needed  im- 
provements. 

In  much  of  the  agitation  concerning  this  increase  in  city  in- 
debtedness, the  increasing  ability  to  pay  its  debts  has  been 
lost  sight  of.  Faster  than  the  increasing  expenditures  has  been 
the  developments  in  the  wealth  and  income  of  the  city.  While  no 
one  can  well  defend  extravagance — why  should  the  investor  be 
filled  with  apprehension  as  long  as  the  power  to  pay  increases? 
When  the  growth  of  expenditures  overreaches  the  increase  in 
income — then  may  the  situation  be  viewed  with  real  apprehen- 
sion. 

Otlner  Debts, — A  mere  statement  of  the  funded  debt  of  a 
state  is  misleading.  A  large  amount  of  floating  debt,  not  in- 
cluded in  the  funded  debt,  may  be  carried  forward  from  year 
to  year,  thus  placing  upon  the  political  division  an  even  more 
burdensome  debt  than  if  it  were  all  in  funded  form.  In  other 
words,  it  might  well  be  called  a  "permanent-floating  debt." 
This  floating  debt  appears  in  various  forms,  ranging  from  the 
current  receivables  to  the  longer  term  warrants  and  the  so- 
called  interest-bearing  obligations.1  The  so-called  contingent 
obligations  would  also  be  classed  under  this  heading. 

The  decision  of  the  court  is,  of  course,  the  ultimate  and 
only  safe  test  as  to  the  legal  position  and  security  of  either 
contingent  issues  or  special  assessment  issues  which  have  been 
questioned.  In  the  use  of  special  assessment  obligations,  most  of 
the  state  courts  have  made  them  a  direct  obligation  of  the 
property  benefited  within  the  special  assessment  district. 
There  are,  however,  numerous  exceptions  to  this  view.  Illinois, 
for  example,  through  its  court  decisions  does  not  permit  debts  of 
special  districts  to  become  a  liability  of  either  a  county  or 
municipality.  Kansas  by  statute  has  made  them  a  direct  obli- 


JSome  of  the  special  assessment  issues  also  might  well  be  placed  in 
the  latter  list.  The  Treasury  department  for  example  does  not  exempt 
certain  special  assessments  of  districts  created  within  the  corporate 
limits  of  a  city  or  town  such  as  paving  or  sewer  securities.  The  Treasury 
department  on  the  other  hand  does  recognize  drainage,  road  and  levee 
districts  when  they  are  subdivisions  of  the  state. 


586  INVESTMENT  ANALYSIS 

gation  of  the  municipality  within  which  they  are  created,  if  the 
issuing  district  defaults.  This  gives  them  a  decided  market 
advantage. 

During  the  early  development  of  a  number  of  counties,  town- 
ships, and  municipalities,  the  eagerness  to  secure  internal  im- 
provements, and  especially  transportation,  caused  a  few  com- 
munities to  guarantee  either  the  principal  and  interest,  or  both, 
of  the  bonds  of  private  corporations.1  These  ill-advised  bonds 
were  issued  under  the  stimulus  of  the  first  wave  of  prosperity 
which  comes  to  every  new  community,  before  it  has  adjusted  it- 
self to  the  slower  and  more  normal  rate  of  growth  of  later  de- 
velopment. Many  of  these  "paper-created"  cities,  some  of 
which  never  exceeded  a  village  in  size,  soon  felt  the  pressure  of 
the  abnormal  burden  they  had  assumed  in  guaranteeing  these 
bonds  and  a  number  were  actually  repudiated.  Where  these 
issues  are  still  alive,  whether  the  corporation  continues  to  exist 
or  not,  they  must  be  counted  as  a  legitimate  part  of  the  fixed 
indebtedness  of  the  issuing  civil  division.  Fortunately  these 
conditions  seldom  arise  excepting  in  very  rare  instances.  But 
despite  the  rare  exception  of  these  issues,  some  writers  have  been 
inclined  to  give  them  undue  importance. 

It  occasionally  happens  that  a  public  utility,  at  the  time 
of  its  purchase  by  a  municipal  corporation,  has  outstanding 
bonded  indebtedness  which  the  municipal  corporation  assumes 
and  expects  to  pay.  Such  bonds,  without  question,  should  be 
ruled  as  obligations  of  the  municipality,  but  such  procedure  does 
not  involve  the  odium  of  a  municipality's  guarantee  of  bonds 
of  private  corporations  in  which  the  city  has  no  interest.  The 
former  is  a  revenue  producing  property  of  the  municipality,  but 
in  the  latter  case  neither  the  property  nor  the  income  there- 
from accrues  to  the  city  as  compensation  for  its  guaranty.  In- 
stances of  bonds  issued  for  assistance  of  private  corporations 
are  rare,  and  do  not  find  a  ready  market  with  responsible 
dealers. 


1Some  authorities  have  made  a  distinction  between  the  guaranteed 
or  indorsed  bond  and  the  straight  railroad  aid.  While  this  technical 
distinction  must  be  recognized,  if  the  former  must  be  met  by  the  in- 
dorser,  it  is,  strictly  speaking,  a  direct  obligation. 


CIVIL  DEBT  587 

The  Actual  Debt  Per  Capita. — The  actual  amount  of  the 
civil  debt  which  any  one  taxpayer  must  pay  is  his  pro  rata 
share  levied  by  the  nation,  state  and  all  minor  political  divisions 
thereof  in  which  he  lives.  A  citizen  of  Chicago,  for  example,  is 
subject  to  his  share  of  the  Federal,  state  and  city  indebtedness, 
as  well  as  that  of  any  other  of  the  same  twenty  separate  tax 
levying  districts  in  which  he  may  have  property  or  of  which 
he  may  be  a  resident.1  As  a  consequence  the  pro  rated  share  of 
either  the  national  or  state  debt  is  a  very  small  proportion  of 
the  total  debt  paid  by  the  taxpayer.  Considering  this,  it  is 
apparent  how  meaningless  the  mere  statement  of  the  general  or 
funded  debt  of  a  county,  township,  city,  or  special  tax  district 
may  be.  No  conclusions  should  ever  be  drawn  of  the  debt  of 
any  one  of  these  civil  units,  unless  the  combined  funded  and 
contingent  debts  of  all  the  tax  jurisdictions  to  which  the  par- 
ticular community  may  be  subject  are  given. 

The  determination  of  the  indebtedness  of  any  one  of  the 
civil  jurisdictions  in  a  state  can  be  illustrated  by  a  discussion 
of  the  real  debt  of  the  county.  The  direct  debt  of  the  area  in- 
cluded in  the  political  division  known  as  the  county,  is  exclu- 
sive of  the  debt  of  all  minor  civil  divisions  included  in  the  same 
geographical  area.  The  direct  debt,  however,  of  the  county  ma: 
be  of  little  significance  when  compared  to  the  total  per  capita 
debt  of  the  same  geographical  area  as  the  county.  Again,  the 
funded  debt  of  the  counties  of  some  of  the  Middle  Western 
states  will  make  a  very  unfavorable  showing  when  compared 
with  the  county  debts  of  such  states  as  New  Hampshire.  A 
comparison  of  state  debts  on  a  per  capita  basis  will  be  most 
favorable  to  the  "Western  states. 

The  effect  of  the  difference  in  the  purposes  for  which  a  tax 
or  a  funded  obligation  can  be  assumed  within  the  borders  of 
one  state  is  well  exemplified  in  the  financing  of  public  roads 
and  highways.  Under  the  present  law,  counties  in  Mississippi 


*A  constitutional  amendment  now  fortunately  provides  that  the 
debt  limit  of  the  city  shall  include  the  debt  of  all  other  civil  districts 
within  the  jurisdiction  of  the  city  limits.  The  situation  will  unques- 
tionably soon  be  changed  after  the  adoption  of  the  new  constitution 
(now  before  the  constitutional  convention  of  1920). 


588  INVESTMENT  ANALYSIS 

can  issue  bonds  for  road  purposes,1  while  in  Rhode  Island  the 
state  finances  all  road  improvements.  Fifteen  states2  which 
have  wholly  or  in  part  built  roads  also  give  either  counties  or 
other  minor  civil  divisions  the  privilege  to  issue  bonds  for  road 
purposes.  All  road  financing  in  Texas  is  done  through  the 
county,  while  Ohio's  roads  may  be  paid  for  by  any  one  or  all 
of  the  following  districts  combined;  namely,  state,  county, 
township,  or  special  road  district. 

It  not  infrequently  happens  that  a  bond  issue  of  a  minor 
division  may  become  a  partial  or  indirect  obligation  of  the 
county.  The  degree  of  certainty  of  its  being  a  direct  obliga- 
tion of  the  county  correspondingly  effects  not  only  the  amount 
of  the  county's  direct  debt  but  the  price  of  the  security.  Now 
this  influence  must  not  be  confused  by  the  uninitiated  in  civil 
finance  with  that  exerted  on  the  price  of  county  securities  by 
cities  within  a  county.  In  the  latter  the  effect  is  exactly  the 
opposite  to  what  it  is  in  the  former,  tending  to  lower  the  rates 
of  all  securities  within  the  county. 

If  doubt  exists  in  this  respect  as  to  the  classification  of  any 
improvement  bonds,  such  as  road  bonds,  a  reference  to  the  court 
decisions  of  the  'locality  will  soon  indicate  the  certainty  or 
uncertainty  of  the  security  holders'  direct  claims  on  the  county. 
As  these  decisions  are  made  by  state  courts,  some  slight  differ- 
ences at  least  must  be  expected  among  the  decisions  of  dif- 
ferent states,  though  in  most  instances  it  is  not  very  marked. 
But  in  civil  loans,  where  the  risk  is  supposedly  reduced  to  a 
minimum  and  a  low  rate  of  return  is  received,  the  fluctuation 
of  even  one-eighth  or  one-quarter  of  one  per  cent  in  the  rate  of 
return  is  of  importance  to  the  purchaser. 

The  difference  between  the  total  debt  and  the  direct  debt  of 
the  county  is,  with  few  exceptions,  the  greatest  in  metropolitan 
counties.  But  the  direct  per  capita  county  debt  of  the  popu- 
lation outside  of  the  city,  while  normally  larger,  in  a  few  in- 
stances is  lower  if  the  city  is  entirely  separated  politically  from 
the  county.  This  again  suggests  the  necessity  of  a  close  study 


1See  Current  State  and  City  Supplement  of  the  Commercial  and 
Financial  Chronicle. 


CIVIL  DEBT  589 

of  the  annual  tax  of  the  county  before  any  final  deductions  are 
made  as  to  the  importance  of  the  funded  debt. 

The  Net  Debt. — The  distinction  between  the  direct  debt  of  a 
particular  civil  division,  and  the  actual  debt  per  inhabitant  to 
the  state  and  its  various  subdivisions  having  been  made,  the 
net  debt  as  distinct  from  the  gross  debt  must  next  be  obtained. 
As  for  obtaining  the  net  debt  from  the  financial  statements  of 
the  state,  the  task  is  relatively  simple. 

With  the  minor  divisions  of  the  state,  the  matter  is  much 
more  complicated.  Lack  of  similarity  in  jurisdictions  and  func- 
tions and  differences  in  the  nomenclature  add  to  the  difficulties 
of  determining  what  shall  be  included  in  the  debt  of  these  divi- 
sions. Having  ascertained  the  meaning  and  limitations  of  these 
latter  factors,  the  work  of  determining  the  net  debt  of  the  minor 
divisions  presents  two  problems;  first,  what  items  must  be  in- 
cluded and  what  items  excluded  in  the  statement  of  a  civil 
division  in  order  to  secure  a  true  estimate  of  the  net  debt? 
Second,  what  debt  or  debts  of  overlapping  jurisdictions  shall 
be  added  or  detached  to  obtain  the  total  debt  whijch  must  be 
paid  by  the  same  group  of  citizens?  In  the  first  case  the  city, 
town,  and  village  are  more  especially  affected,  because  of  the 
character  of  the  items  likely  to  be  included  or  excluded  in  the 
indebtedness.  Particular  stress  should  be  given  to  the  amount 
of  floating  debt  and  perhaps  the  general  items  of  which  it  is 
composed.  Also  consideration  should  be  given  to  such  muni- 
cipally owned  properties  as  are  productive  of  net  income  over 
the  cost  of  operation,  maintenance,  etc.  In  the  various  items 
included  in  these  two  classifications  are  included  the  items  over 
which  the  greatest  differences  of  opinion  arise,  especially  in 
court  decisions,1  i.  e.,  what  shall  be  included  in  the  municipal 
debt.  When  the  net  debt  of  the  individual  civil  unit  is  cor- 
rectly determined,  it  is  a  fairly  simple  matter  to  obtain  the 
total  debt  to  which  any  one  of  the  overlapping  jurisdictions  is 
subject.  Moreover  in  addition  to  the  amount  of  the  floating 


vs.  Ninety-six,  159  U.  S.  611 ;  Fallbrook  Irrigation.  District 
vs.  Bradley,  164  U.  S.  112;  Town  of  Darlington  vs.  Atlantic  Trust  Co., 
16  C.  C.  A.  28,  68  Fed.  849.  Cases  in  which  purpose  was  not  considered 
public ;  Dodge  vs.  Mission  Tp.,  Shawnee  County,  Kan.,  107  Fed.  827 ; 
Pleasant  Tp.  vs.  Etna  Life  Insurance  Co.,  138  U.  S.  67. 


590  INVESTMENT  ANALYSIS 

debt,  the  length  of  time  that  this  debt  has  been  outstanding 
should  be  known. 

Where  the  property  securing  the  obligation  is  self-sustaining, 
there  seems  as  little  justification  for  including  it  as  a  part  of 
the  debt  of  the  municipality,  as  there  is  in  including  the  debt 
of  a  privately  owned  public  utility.  If  the  debts  of  this  prop- 
erty are  deducted,  it  should  be  made  certain  that  the  property 
is  self-sustaining.  If  the  property  is  not  self-sustaining,  even 
where  the  court  or  a  statute  allows  a  deduction  of  any  specific 
debt  which  is  a  general  obligation  of  the  city,  created  for  the 
purpose  of  financing  a  public  utility,  such  indebtedness  should, 
of  course,  be  taken  into  consideration  in  the  debt  statement. 
If  this  were  not  done,  the  municipal  statement  would  be  an 
incorrect  exposition  of  the  city's  finances,  as  the  interest  on 
such  indebtedness,  or  such  portion  as  is  not  derived  from  the 
operation  of  the  public  service  property,  would  necessarily  be 
met  by  the  levy  of  a  direct  tax  on  the  general  property  of 
the  community.  Debts  created  for  the  purpose  of  financing 
city  owned  -and  operated  water-service  plants,  electric  light  and 
gas  plants  are  the  form  of  funded  indebtedness  most  often 
excluded  by  state  constitutions,  statutes  or  court  decisions,  as 
part  of  the  debt  of  the  municipality. 

Debt  Restrictions. — The  restriction  or  limitation  of  civil  debt 
is  accomplished  directly  in  three  ways:  (1)  by  constitutional 
restrictions;  (2)  by  court  decisions,  and  (3)  by  statutory  re- 
strictions. Any  complete  treatment  of  the  statutes  and  court 
decisions  of  civil  debt  is  impractical  and  a  complete  legal  train- 
ing is  almost  essential  for  an  understanding  of  court  decisions, 
so  intricate  are  the  discriminations  of  the  law.  Constitutional 
restrictions  can  be  summarized  with  some  degree  of  complete- 
ness and  understanding. 

The  chief  constitutional  restrictions  of  the  states  may  be 
summarized  as  follows:  (1)  The  states,  with  a  few  exceptions, 
can  raise  an  unlimited  amount  to  repel  invasions  and  suppress 
insurrections.  States,  however,  have  seldom  ever  raised  funds 
under  this  provision.  (2)  The  purposes  for  which  the  common- 
wealths can  borrow  are  usually  specifically  stated.  (3)  The 
constitution  usually  regulates  the  issue  of  bonds  for  deficits  and 


CIVIL  DEBT  591 

extraordinary  purposes,  and  a  specified  vote  is  also  required, 
as  in  number  2.  (4)  The  state  can  neither  own  stocks  in,  nor 
loan  its  credit  to  a  private  corporation,  and  a  legislative  act 
authorizing  such  purchase  would  be  contradictory  to  the 
state  constitution.  (5)  The  legislatures  are  prohibited  from 
enacting  laws  assuming  indebtedness  above  a  certain  amount, 
or  incurring  indebtedness  for  internal  improvements  except 
under  constitutional  regulations  and  then  for  only  a  brief 
period.1 

The  most  common  regulation  found  among  the  state  con- 
stitutions is  the  requirement  of  a  popular  vote  before  a  funded 
loan  above  a  certain  amount  can  be  made  by  the  state.2  A  few 
states,  as  Wisconsin,  require  a  certain  percentage  of  the  total 
vote  of  the  upper  and  lower  houses.  Connecticut,  Massa- 
chusetts, New  Hampshire,  and  Vermont  have  no  restrictions  of 
any  kind  on  their  state  indebtedness.  Where  no  restriction  is 
placed  on  temporary  loans  for  extraordinary  purposes,3  it  might, 
as  has  been  experienced,  offset  the  value  of  funded  debt  limita- 
tions. It  does,  however,  relieve  the  embarrassment  that  a  few 
states  would  experience  if  forced  to  raise  funds  under  extraor- 
dinary circumstances,  if  the  legality  of  the  issue  is  to  be  pre- 
served. It  is  undoubtedly  well  to  have  a  fixed  amount  for  tem- 
porary loans  to  prevent  possible  extravagance,  but  the  elastic 
privilege  of  an  unlimited  amount  when  approved  by  popular 
vote  for  extraordinary  purposes,  as  in  Kansas,  is  carrying  the 
privilege  to  an  extreme.  On  the  other  hand,  the  maximum  of 

^Missouri  limits  borrowing  for  temporary  debts  to  two  years  [Con- 
stitution (1875),  Art.  IV.,  Sec.  44]. 

'Popular  vote  for  increasing  debts  above  a  certain  minimum  is  re- 
quired, for  example,  by  the  constitutions  of  California,  Illinois,  Iowa, 
Michigan,  New  Jersey,  New  York,  and  Rhode  Island. 

'Delaware.  Indiana,  North  Carolina.  South  Carolina.  Virginia,  and 
West  Virginia  have  no  limit  fixed  in  their  constitutions  for  temporary 
loans.  Arkansas,  Florida.  Louisiana,  and  Mississippi  have  no  provisions 
of  any  kind,  and  Colorado.  Idaho  and  Wyoming  have  special  provisions 
that  automatically  regulate  the  amount.  All  other  states  have  some 
fixed  limitation  or  special  regulation  of  the  amounts  of  temporary 
loans  that  may  be  issued.  It  might  be  said,  however,  that  while  Louis- 
iana requires  no  vote  it  does  require  a  constitutional  amendment,  giv- 
ing power  to  the  legislature  to  authorize  the  issuance  of  securities  which 
are  state  obligations,  and  as  a  change  in  the  constitution  must  be  had 
by  a  vote  of  the  people,  it  really  operates  as  though  the  particular  issue 
had  been  directly  voted  upon.  This  is  true  of  other  states. 


592  INVESTMENT  ANALYSIS 

$50,000  for  temporary  loans  in  Oregon,  for  example,  would 
not  be  sufficient  to  pay  even  the  salaries  of  its  officials.  A  few 
states  have  specific  regulations  as  to  the  duration,1  as  well  as 
to  the  amount  of  the  loans. 

The  constitutional  regulation  of  the  duration  of  fixed  debts 
has  no  common  basis.  It  runs  from  a  maximum  of  ten  years  in 
Minnesota,  to  seventy-five  years  in  California,  and  "when  due" 
in  Kansas,2  and  South  Dakota.  Where  amendments  affecting 
state  indebtedness  have  been  made  to  constitutions,  the  tendency 
has  been  to  increase  the  duration.  Not  a  few  states  have 
avoided  these  time  regulations  by  the  refunding  of  old  issues  as 
they  fall  due.  This  is  now  quite  possible  as  the  period  of  renewals, 
even  in  regulated  states,  is  quite  flexible.  A  fixed  as  well  as 
a  moderate  period  of  duration  does  have  the  advantage  of  the 
readjustment  of  the  loan  to  new  statute  regulations  and  the 
changes  in  interest  rates.  The  remaining  important  constitu- 
tional regulations  are  fairly  uniform  and  space  will  not  permit 
a  discussion  of  them. 

The  number  of  states  possessing  constitutional  limitations 
of  municipal  debt  is  in  excess  of  those  having  legislative  restric- 
tion, though  increased  restrictions  are  found  in  almost  all  states 
which  have  any  form  of  constitutional  control.  In  nine  states 
this  power  of  limitation  is  given  over  to  the  legislative  bodies.3 
In  North  Carolina  and  Tennessee,  for  example,  the  control  of 
debt  issues  is  given  in  the  municipal  charter.  This  is  also  true 
of  a  number  of  towns  in  other  states  incorporated  under  old 
charters  by  special  legislative  acts.  Maryland  still  clings  to  the 
old  archaic  form  of  a  special  legislative  act  for  every  issue  made, 


JThe  following  states  have  specific  regulations  governing  the  dura- 
tion of  fixed  debts:  California  (75  years),  Colorado  (10  to  15),  Idaho 
(20),  Iowa  (20),  Kansas  (when  due),  Kentucky  (30),  Maryland  (15), 
Minnesota  (10),  Missouri  (13),  Nevada  (20),  New  Jersey  (35),  New 
York  (50),  North  Carolina  (30),  Oklahoma  (25),  South  Carolina  (40). 
South  Dakota  (when  due),  Washington  (20),  West  Virginia  (20),  and 
Wisconsin  (20). 

^his  limit  can  as  in  some  other  states  be  fixed  by  the  legislature 
and  this  power  has  alwavs.  been  exercised  where  given  (Kansas,  Con- 
stitution, Art.  XII,  Sec.  5). 

"New  Hampshire  (Abbott's,  Laics  of  Public  Securities,  p.  902)  and 
Kansas  (Constitution  Art.  XII,  Sec.  5)  are  examples  of  legislative  con- 
trol. 


CIVIL  DEBT  593 

a  condition  which  necessitates  the  examination  of  each  statute 
authorizing  the  loan. 

The  most  common  basis  of  restriction  is  that  which  limits  the 
debt  to  a  ratio  of  the  assessed  valuation.  A  comparison  of  the 
obligations  of  two  or  more  states  on  this  basis,  as  suggested  in  a 
previous  chapter,  may  be  quite  misleading.  On  the  other  hand, 
as  previously  stated,  if  the  assessed  valuation  and  the  rate  of 
assessment  be  known,  the  market  value  can  be  easily  computed. 
For  practical  purposes  this  is  all  that  is  wanted,  for  the  check 
can  then  be  made  on  the  relative  importance  of  the  debt  by  use 
of  ratios. 

Professor  Horace  Secrist  says  in  criticism  of  this  standard 
of  debt  limitation  that :  ' '  Constitutional  restrictions  based  upon 
the  assessed  value  of  property  are  imposed  to  prevent  public 
credit  being  abused.  But  if  property  is  under-assessed,  then 
the  use  of  credit  is  prevented  to  the  degree  of  the  under-assess- 
ment  even  when  a  policy  of  deficit  financiering  is  justified,  and 
also  when  the  debt  limit  in  reality  has  not  been  reached  when  it 
is  measured  in  terms  of  actual  property  value.  To  make  the 
borrowing  power  a  certain  percentage  of  the  assessed  value  of 
property  answers  only  half  of  the  problem,  and  this  part  in  an 
unscientific  manner.  Borrowing  is  a  necessary  financial  device 
for  public  corporations  to  employ.  It  is  liable  to  abuse,  how- 
ever, and  needs  to  be  regulated,  but  regulation  must  not  be 
made  dependent  upon  the  willingness  or  ability  of  local  as- 
sessors to  correctly  or  uniformly  evaluate  property." 

The  evil  results  of  a  too  narrow  or  rigid  limitation  by  con- 
stitution or  statute  are  reflected  in  the  forced  amendments 
that  have  been  necessary  in  order  to  give  relief  to  a  munici- 
pality. Within  reasonable  limits  this  over-ruling  of  a  restric- 
tion by  extending  special  favor  may  be  justified,  but  as  a  gen- 
eral principle  it  is  bad.  South  Carolina  has  without  question 
made  the  greatest  abuse  in  the  past  of  these  specially  granted 
privileges  of  evading  the  debt  limit.' 

Refunding  of  municipal  issues  is  generally  not  permitted, 


JHorace  Secrist,  An  Economic  Analysis  of  the  Constitutional  Restric- 
tions Upon  Public  Indebtedness  in  the  United  States   (1914),  p.  87. 
2See  Code  Laws  of  South  Carolina  (1912)  vol.  ii,  p.  632  and  others. 


594  INVESTMENT  ANALYSIS 

though  in  some  states  an  issue  may  be  refunded  for  a  few  spe- 
cified purposes.  As  a  general  practice,  however,  this  is  neither 
a  sound  nor  a  conservative  method  of  financing  where  the  funds 
have  not  been  used  for  revenue  producing  purpose.1 

One  of  the  more  recent  restrictions  of  municipal  funded 
debt,  limits  the  municipality  to  making2  issues  for  certain 
designated  purposes.  These  purposes  are  now  principally  con- 
fined to  what  may  be  termed  public  affairs  as  distinct  from 
individual  or  private  corporation  affairs.  They  include  such 
enterprises  as  courthouses,  county  and  city  buildings,  bridges, 
jails,  roads,  school  houses,  fire  stations,  sewers,  and  other  forms 
of  municipalized  public  utilities.  It  is  still  possible  in  certain 
states  for  a  political  division  to  make  an  issue  for  certain  pur- 
poses, as  for  example,  municipalities  in  Nebraska  may  issue 
bonds  to  assist  railroads  Or  other  private  internal  improve- 
ments, not  to  exceed  5  per  cent  of  the  taxable  property  of  the 
municipality.3  The  majority  of  states,  however,  forbid  issuing 
bonds  for  such  purposes. 

As  to  specific  control  of  debt,  four  states  limit  debt  in  rela- 
tion to  the  current  income ;  Utah4  and  Wyoming5  not  to  exceed 
the  current  taxes  of  the  current  year  except  by  a  vote  of  the 
people,  and  California*  and  Idaho7  not  to  exceed  the  income 
and  revenue  for  the  current  year  except  by  a  two-thirds  vote 
of  the  people.  Massachusetts  now  requires  that  all  current  ob- 
ligations of  municipalities,  etc.,  shall  be  certified  in  order  to 
avoid  over-issue.8  This  is  a  method  of  control  which  might  well 


1Vermont  is  an  illustration  of  a  state  allowing  refunding  for  cer- 
tain purposes.  See  Public  Statutes  (1906)  chap,  clvii. 

JAlong  with  the  purpose  of  issue  a  definite  restriction  is  sometimes 
put  on  the  duration,  though  more  often  there  is  no  definite  relation 
between  them,  as  is  later  referred  to  under  the  topic  of  the  Duration 
of  the  Loan. 

"See  Nebraska  Constitution,  Art.  XII,  Sec.  2,  and  also  Revised 
Statutes  (1915),  Sec.  5. 

Constitution,  Art.  XXIV,  Sec.  3. 

"Constitution,  Art.  XVI,  Sec.  4. 

"Constitution,  Art.  XI,  Sec.  18. 

'Constitution,  Art.  VIII,  Sec.  3. 

"See  Annual  reports  on  the  Statistics  of  Municipal  Finances  of  Mas- 
sachusetts ;  see  also  Charles  F.  Gettemy,  the  New  Massachusetts  Legis- 
lation Regulating  Municipal  Indebtedness,  Nat.  Municipal  Rev.,  vol.  iii, 
pp.  682-692  (1914). 


CIVIL  DEBT  595 

be  adopted  by  all  states.  Effectively  administered,  it  should 
work  as  an  automatic  check  to  over-issue. 

Like  the  state,  the  minor  political  divisions  of  the  state  can 
borrow  for  certain  stipulated  reasons  set  forth  by  state  con- 
stitution or  statute.  The  more  common  of  these  restrictions 
regulate:  the  amount  of  the  debt  in  relation  to  assessed  valua- 
tion; the  tax  rate  in  relation  to  debt;  the  refunding  of  out- 
standing issues ;  the  purposes  of  issue ;  the  relation  and  amount 
of  funded  debt  to  current  debt;  the  duration,  the  payment;1 
the  inclusion  or  exemption  of  the  debt  of  revenue  producing 
utilities  owned  by  the  municipality  from  the  total  debt  of  the 
municipality;  and  the  referendum  required  before  a  funded 
debt  can  be  made  legal.  In  addition  to  this,  the  municipal 
governments  are  required  in  most  instances  to  levy  a  tax  at  the 
time  of  the  issue,  sufficient  to  provide  sums  in  each  of  the 
following  years  for  the  payment  of  the  interest  and  principal  at 
maturity.*  Such  a  pledge  by  the  issuing  municipal  authorities 
can  be  compelled  by  mandamus  proceedings. 

The  most  recent  development  in  constitutional  restrictions 
has  been  the  exclusion  of  public  utility  debts  as  a  part  of  the 
indebtedness  of  municipalities;  the  more  numerous  of  these 
exclusions  are  debts  incurred  for  the  acquisition,  maintenance 
or  extension  of  public  service  water  plants.  Virginia'  has  pro- 
vided a  most  important  qualification  in  requiring  that  water- 
plants  be  self-sustaining,  and  in  addition  setting  aside  a  suffi- 
cient amount  to  provide  for  a  sinking  fund  to  retire  the  bonds 
at  maturity.  For  greater  effectiveness,  provisions  should  be 
made  guaranteeing  to  these  enterprises  such  rates  as  will  allow 
them  to  be  self-sustaining;  otherwise  they  put  upon  the  tax- 
payer an  added  debt  burden. 

Virginia's  constitutional  provisions  governing  the  original 
issue,  amply  protect  the  community  and  the  investor  at  the 
time  of  issue,  but  it  is  during  the  subsequent  period  that  these 
enterprises  may  resolve  themselves  into  an  increased  burden  on 


JSee  discussion  of  Duration  and  Payment  in  subsequent  topic. 

2New  York  Constitution  1894,  Amended  1909,  Art.  VIII,  Sec.  10. 

•Constitution  (1902),  Sec.  127;  see  also  Michigan's  interesting  pro- 
vision for  the  purchase  of  public  utilities,  Public  Acts  of  Michigan 
(1909),  chap.  278,  Sec.  26. 


596  INVESTMENT  ANALYSIS 

the  community.  Though  the  investor  is  fully  protected  by  the 
loan  becoming  a  general  obligation  of  the  municipality,  as  a 
matter  of  sound  investment,  the  "corporation  plant"  should 
be  completely  maintained. 

The  New  York  amendment  of  1909  to  its  constitution  treats 
of  these  exemptions  with  far  greater  completeness;1  "for  a 
public  improvement  owned  or  to  be  owned  by  the  city  which 
yields  to  the  city  current  net  revenue,  after  making  any  neces- 
sary allowances  for  repairs  and  maintenance  for  which  the  city 
is  liable,  in  excess  of  the  interest  on  said  debt  and  of  the  annual 
installments  necessary  for  its  amortization,  may  be  excluded  in 
ascertaining  the  power  of  said  city  to  become  otherwise  in- 
debted, provided,  that  a  sinking  fund  for  its  amortization  shall 
have  been  established  and  maintained  and  that  the  indebtedness 
shall  not  be  so  excluded  during  any  period  of  time  when  the 
revenue  aforesaid  shall  not  be  sufficient  to  equal  the  said  inter- 
est and  amortization  installments,  and  except  further  than  any 
indebtedness  heretofore  incurred  by  the  city  of  New  York  for 
any  rapid  transit  or  dock  investments  may  be  so  excluded  pro- 
portionally to  the  extent  to  which  the  current  net  revenue 
received  by  said  city  therefrom  shall  meet  the  interest  and 
amortization  installments  therefore,  provided  that  any  increase 
in  the  debt  incurring  power  of  the  city  of  New  York  which  shall 
result  from  the  exclusion  of  debts  heretofore  incurred  shall  be 
available  only  for  the  acquisition  or  construction  of  properties 
'to  be  used  for  rapid  transit  or  dock  purposes. ' '  Oklahoma,  next 
to  New  York  and  Virginia,  has  proceeded  the  furthest  in  the 
exemption  of  the  debt  of  self-supporting  properties  of  munici- 
palities. States  exempting  municipal  public  utility  debt  from 
taxation  are  Oklahoma,2  Arizona,8  Montana,4  New  Mexico,5  North 
Dakota,6  South  Dakota/  Utah,8  Washington,9  and  Wyoming.19 


York  Constitution,  1894,  Amended  1909,  Art.  VIII,  Sec.  10. 
Constitution,  1901,  Sec.  225. 
•Constitution,  1911,  Art.  IX,  Sec.  8. 

Constitution,  1SS9,  Art.  XIII,  Sec.  6  (Amount  not  stated). 
"Constitution,  1911,  Art.  IX,  Sec.  13. 
"Constitution,  1889,  Sec.  183. 
'Constitution,  1889,  Art.  XIII,  Sec.  4. 
"Constitution,  1895,  Art.  XIV,  Sec.  4. 
'Constitution,  1889,  Art.  VIII,  Sec.  6. 
"Constitution,  1889,  Art.  XVI,  Sec.  5. 


CIVIL  DEBT  597 

Most  bond  issues  of  the  civil  divisions  of  a  state  must  receive 
the  referendum  of  the  voters  of  the  political  division.  Twelve 
states  require  this  for  all  bonds  before  they  can  be  issued. 
Seven  states  require  this  vote  on  issues  above  a  certain  amount. 
Others  meet  this  requirement  by  signed  petitions.  The  number 
of  votes  or  signatures  required  on  these  petitions  is  from  one-half 
to  two-thirds  of  the  number  of  property  owners  within  the 
minor-political  division  who  are  recipients  of  the  benefits  of 
the  bond  issues. 

Duration  of  the  Funded  Debt. — Lastly,  an  important  prob- 
lem in  the  payment  of  debt  is  the  duration  of  the  loan.  No 
important  study  of  the  effect  of  duration  of  municipal  bonds 
in  the  United  States  upon  price  has  ever  been  made,  and  the 
difficulty  of  divorcing  it  from  other  influences  would  probably 
make  it  difficult  to  establish  any  definite  conclusions.  There  is 
a  wealth  of  material  upon  the  whole  subject  of  municipal  bonds 
which  has  never  been  touched,  but  which  we  shall  eventually  be 
forced  to  study.  The  irredeemable  loans  formerly  used  by 
European  countries  have  never  met  with  favor  in  this  country. 
We  have  always  been  a  debt  paying  country;  hence  irredeem- 
able loans  need  not  be  given  any  consideration.  Maximum 
limits  should  be  placed  upon  all  loans,  though  some  elasticity 
should  be  permitted  below  this  maximum  limit.  Neither  should 
the  same  duration  be  applied  to  all  loans.  Certain  types  of 
improvements  of  even  the  same  character  will  vary  in  the  extent 
of  their  lives  in  the  same  city  according  to  the  extent  to  which 
they  are  used.  Consequently,  the  maximum  term  for  these 
securities  enacted  by  law  should  be  less  than  the  term  of  the 
improvement. 

England's  precedence,  in  this  regard,  is  an  excellent  guide 
for  us  to  follow.1  An  effort  has  been  made  in  its  regulations 
to  make  adaptation  of  the  length  of  the  period  of  the  loan  to 
the  life  of  the  utility.  The  periods  vary  from  ten  to  sixty  years 
and  are  determined  by  a  Local  Government  Board  provided 


Horace  Secrist,  An  Economic  Analysis  of  the  Constitutional  Re- 
strictions Upon  Public  Indebtedness  of  the  United  States  (1914). 
pp.  112-115.  ( See  also  the  quoted  sources  of  this  author  in  footnotes : 
Report  of  the  Select  Committee  on  Repayment  of  Loans  by  Local 
Authorities,  1902,  pp.  iv,  v ;  also  Appendices  of  this  report. 


598  INVESTMENT  ANALYSIS 

with  an  expert  staff  of  engineers  who  can  correctly  advise  on 
the  life  and  kindred  problems  of  utilities.1  The  Ontario  and 
Municipal  Board  of  Ontario,  Canada,  performs  much  the  same 
function.* 

"While  the  theoretical  argument  seems  most  convincing  for 
the  extension  in  the  maturities  of  bonds  on  a  certain  class  of 
improvements,  it  is  doubtful  whether  our  present  form  of  con- 
trolling municipal  finance  makes  this  yet  practicable.  To  leave 
this  problem  for  local  officials  to  solve  is  equivalent  to  leaving 
it  unsolved,  and  to  furnish  the  opportunity  for  the  wholesale 
abuse  of  credit  and  the  waste  of  money.3  The  payment  of  debt 
also  serves  to  increase  potentially  the  municipality's  credit. 

Payment  of  the  Debt. — The  payment  of  civil  loans  is  quite 
a  distinct  problem  from  that  of  the  payment  of  private  cor- 
poration debt.  In  the  former,  the  equalization  of  tax  distribu- 
tion between  the  present  and  the  future  and  the  prevention  of 
the  continued  accumulation  of  debt  which  will  be  handed  on 
to  future  generations  are  the  chief  concern.  In  corporate  finance 
funded  debt  is  usually  indefinitely  continued  by  renewals  and 
increased  where  corporate  growth  justifies.  Corporate  debt  and 
interest  must  be  paid  out  of  revenues  from  operation;  civil 
bonds  must  be  met  from  revenues  derived  from  taxation.  To 
place  an  unequal  burden  on  either  the  present  or  the  future, 
forces  the  generation  bearing  the  unequal  share  to  pay  for  the 
privileges  enjoyed  by  the  other.  To  avoid  this,  civil  loans  must 
be  paid  off.  What,  then,  is  the  most  economical  and  safest 


lThe  Economic  Journal  (London),  vol.  xiv,  p.  47-56. 
"Statute  (Ontario  Province,  Canada)  6  Ed.  viii,  chap,  xxxi,  see  also 
E.  G.  Long,  Canadian  Hunicpal  Bonds,   Synopsis  of  Laics  Governing 
Issues,  pp.  4-12. 

"The  North  Dakota  State  Tax  Association  relates  this  now  well- 
known  story  of  a  fire  engine  in  Grand  Forks  told  in  the  following  state- 
ment : 

Original  fire  engine  cost  $6,000 

Plus  interest  35  years : 

(1)  On  $6,000  at  7%  for  15  years 6,300 

(2)  On  $5.000  Refunding  Bonds  at  6%  for 

20  years 6.000 


$18.300 

Still   due  at   time  of   this   statement   $5.000   and   fire 
engine  in  junk  heap  for  10  years. 


CIVIL  DEBT  599 

method  by  which  these  loans  may  be  paid?  Do  any  of  these 
methods  of  payment  have  particular  advantages  in  the  pay- 
ments of  civil  loans?  Such  conclusions  as  are  drawn  in  the 
following  discussion,  however,  the  reader  must  remember,  are 
not  meant  to  apply  to  corporation  loans. 

The  most  common  method  of  providing  for  the  payment  of 
loans  is  by  the  sinking  fund.  This  is  a  fund  accumulated  at 
certain  regular  intervals  and  used  for  the  immediate  reduc- 
tion of  the  debt  or  invested  in  interest  bearing  securities  which 
are  held  until  the  maturity  of  the  whole  debt.  These  securities 
may  be  securities  of  the  same  issue  or  of  other  civil  loans  or 
corporation  bonds.  The  serial  method,  a  more  recent  form  of 
payment,  provides  that  stipulated  amounts  of  the  principal  to- 
gether with  the  interest  payments  shall  come  due  on  certain 
interest  payment  dates  over  a  period  of  years.  A  number  of 
states  permit  the  refunding  of  old  issues — a  practice  which  per- 
mits payment  without  the  raising  of  funds.  When  no  pre- 
vious provisions  have  been  made  for  the  raising  of  such  funds, 
the  bonds  are  usually  refunded,  especially  where  the  bond 
issue  is  very  large  relative  to  the  revenues  received. 

The  sinking  fund  was  originally  applied  to  national  loans 
and  has  changed  little  from  its  first  form.1  The  national  sink- 
ing fund  as  evolved  originally  contemplated  the  payment  an- 
nually to  the  "Board  of  Commissioners  of  the  Sinking  Fund" 
of  a  certain  percentage  of  the  debt,  usually  one  per  cent.  The 
interest  on  this  fund,  compounded  annually,  was  to  go  to  swell 
the  fund,  and  thus  the  process  of  "sinking"  the  debt  was  ex- 
pected to  be  constantly  accelerated.  In  1772,  one,  Dr.  Price  in 
England,  wrote  his  "Appeal  to  the  Public  on  the  Subject  of  the 
National  Debt,"  in  which  he  laid  down  the  sinking  fund  doc- 
trine. His  work  continued  to  be  the  standard  guide  of  finan- 
ciers for  the  greater  part  of  a  century.  Dr.  Price  went  to 
the  extent  of  advocating  borrowing  in  order  to  maintain  the 
sinking  fund  payments,  as  only  simple  interest  was  paid  on 


JFor  modern  methods  of  handling  the  sinking  fund  see:  Park  Ter- 
rell, The  American  Cit)/  (Feb..  1911),  p.  57;  Thomas  B.  Frost,  The  Gov- 
ernment Accountant  (Oct.,  1911),  pp.  268-274;  English  Parliamentary 
Report,  June  16,  1909. 


600  INVESTMENT  ANALYSIS 

the  sums  borrowed,  but  when  the  money  was  in  the  sinking  fund 
it  drew  compound  interest. 

It  used  to  be  said — and  the  statement  is  sometimes  still  made 
— that  the  sinking  fund  has  the  advantage,  from  the  debtors' 
standpoint,  of  a  lower  rate  than  the  serial  method  of  payment. 
There  may  originally  have  been  cases  where  a  municipality's 
maiden  attempt  at  serial  bond  issues  necessitated  a  higher  rate 
being  offered,  but  this  was  not  true  generally  or  was  it  long 
continued.  As  far  back  as  1886,  Brookline,  Massachusetts, 
placed  its  first  serial  bond  loan  of  $100,000  without  difficulty 
at  3.65  per  cent  and  since  that  time  it  has  placed  fifty-eight 
loans  aggregating  about  $3,600,000  at  an  average  rate  of  3.50 
per  cent.1 

The  important  thing  in  sinking  funds  is  their  management. 
Failures  in  administration  have  been  the  trouble  in  the  past. 
A  good  share,  then,  of  what  is  said  against  the  sinking  fund 
system  turns  upon  the  question  of  investment.  Just  how  im- 
portant this  question  may  become  is  shown  in  the  financial  con- 
dition of  the  state  of  Massachusetts  on  September  30,  1913. 
On  that  date  the  state  had  $34,674,498  in  sinking  funds  on 
hand.2 

Cash  accumulations  for  the  sinking  fund  may  have  the  good 
effect  of  bolstering  up  the  municipality's  credit.  Cash  funds 
in  a  bank  bring  a  low  rate,  while  if  properly  invested  they 
may  be  made  to  earn  considerably  more.  Then,  too,  cash  funds 
on  hand  in  a  bank  may  tempt  officials  to  misappropriate,  where 
no  legal  restrictions  exist.  Experience  seems  to  indicate  that 
with  the  national  loans  of  long  tenure  payments  into  sinking 
funds  have  had  little  success.3 

Because  of  the  uncertainty  of  interest  rates  obtained,  the 
necessary  investment  in  securities  may  not  produce  sufficient 
funds  to  liquidate  the  loan  at  maturity  or  it  may  create  a  sur- 
plus. Further,  when  other  securities  are  bought,  it  may  be 
necessary  to  sell  them  at  the  maturity  of  the  loan  even  though 


1A.  D.  Chandler,  Metropolitan  Debts  of  Boston  and,  Vicinity  (1913), 
pp.  9-10. 

2A.  D.  Chandler,  Ibid.,  p.  8. 

3E.  A.  Ross,  Sinking  Funds,  Amer.  Econ.  Rev.  vol.  vii  (1892), 
p.  395.  (See  also  case  of  Riddleberger  Bonds  of  Virginia.) 


CIVIL  DEBT  601 

the  market  may  not  be  advantageous.  These  objections  are  in 
a  measure  overcome  by  the  practice,  as  in  Massachusetts,  of 
basing  the  computations  for  sinking  funds  on  the  assumption 
that  the  funds  should  earn  3y2  per  cent  annually,  this  being 
a  conservative  rate  for  the  basis  of  a  uniform  computation. 

Borrowing  for  the  sinking  fund  is  never  justifiable  and  has 
often  jeopardized  the  fund.  It  also  adds  to  the  debt  instead  of 
decreasing  it.  A  few  courts  have  forbidden  the  practice  of 
borrowing  to  pay  the  fund,  on  the  ground  that  it  is  detrimental 
to  the  municipality.  The  practice  of  borrowing  is  also  likely  to 
lead  to  greater  extravagance  in  expenditures. 

A  great  many  of  the  false  conclusions  that  have  been  arrived 
at  by  officials  and  legislatures  have  arisen  from  the  idea  that 
interest  money  paid  by  a  government  on  its  own  securities  into 
its  sinking  funds  is  income,  i.  e.,  that  such  sinking  funds  are 
productive.  "That  cannot  be  regarded  as  productive  property 
to  the  government  which  rests  upon  taxes  levied  and  collected 
by  the  government.  It  is  the  taxes  that  are  the  sources  of 
revenue  and  not  the  fund." 

In  a  number  of  states,  the  municipalities  are  required  by 
statute  to  provide  for  the  accumulation  of  a  sinking  fund,  and 
it  is  also  a  common  practice  even  where  it  is  not  obligatory,  to 
use  this  provision.  The  Federal  Census  Bureau  states  of  its 
operation:  "For  the  greater  number  of  cities  the  sinking  funds 
are  prudently  and  economically  administered.  .  .  .  In  a  small 
number  of  cities,  however,  the  cash  accumulations  in  the  funds 
have  been  diverted  to  current  city  expenses,  with  the  result 
that  the  so-called  assets  of  the  funds  are  merely  accounting 
entries  and  therefore  do  not  constitute  true  offsets  to  the  bonded 
debt."  Even  where  taxes  are  provided,  the  loose  accounting 
systems  have  caused  the  easy  disappearance  of  these  funds  for 
other  purposes.1 


1H.  C.  Adams.  Public  Debts  (1S92),  pp.  244-254. 

'Bureau  of  Census,  Statistics  of  Cities  Having  Population  of  Over 
30,000  (1907),  (printed  1910),  p.  73. 

*Up  to  April  1,  1915,  the  Sinking  Funds  of  the  New  York  Canal 
debt  amounted  in  three  years  to  one-fourth  of  the  amount  outstanding, 
although  the  bonds  had  an  average  of  45  years  to  mature.  (Bureau 
of  Municipal  Research,  No.  60,  April,  1915,  p.  1.) 


602  INVESTMENT  ANALYSIS 

So  common  have  been  the  looseness1  and  errors  with  which 
sinking  funds  have  been  administered  since  their  first  conception 
that  their  use  for  civil  loans  must  be  seriously  questioned, 
except  under  the  most  rigid  control.2  Under  the  rigid  econ- 
omy necessary  for  safety,  they  are  expensive. 

Even  if  the  sinking  fund  will  do  all  that  is  claimed  for  it, 
its  plan  of  payment  is  more  costly  than  the  serial  method.  This 
is  due  to  the  fact  that  interest  must  be  paid  on  the  entire  loan 
throughout  its  life  while  under  the  serial  method  the  interest 
is  annually  diminishing  and  also  to  the  fact  that  sinking  fund 
investments,  as  pointed  out,  bring  in  only  a  low  average  yield.3 

Certainly  if  the  sinking  fund  is  to  be  used,  a  single  sinking 
fund  should  not  be  made  to  cover  all  issues.  Each  loan  should 


aThe  sinking  fund  has  easily  lent  itself  to  the  temptation  of  mis- 
appropriation where  strict  requirements  of  the  application  of  money 
belonging  to  the  sinking  fund  have  existed.  The  Consolidated  Municipal 
Act  of  Ontario,  Canada  (Sec.  S),  1903,  has  incorporated  a  clause  to 
protect  the  municipalities  against  these  evils. 

2H.  C.  Getteinay,  Director  of  the  Bureau  of  Statistics  in  Massa- 
chusetts, in  investigation  of  twelve  hundred  sinking  funds  found  dis- 
crepancies in  forty  towns  and  cities  of  $1.794,391.58  and  net  surpluses 
in  forty-seven  towns  and  cities  of  $2,855,192.37. 

See  also  study  of  the  New  York  State  Sinking  Funds  by  the  Bureau 
of  Municipal  Research  (1915),  p.  277. 

"Under  the  sinking  fund  the  interest  charge  is  the  same  from  year 
to  year  while  the  interest  charge  under  the  serial  method  of  payment, 
as  Mr.  Chandler  states  in  his  computation,  is  continually  being  reduced : 
"$1,000,000  at  3%  for  20  years.    Comparison  between  Sinking  Fund 
and  Serial  Bond  Methods. 

By  the  Sinking  Fund  method  the  interest  at  3%  is $600,000 

By  the  Serial  Bond  method  the  interest  at  3%  is 315,000 

Difference  in  interest  in  favor  of  Serial  Bonds  $285,000 


$1,000,000  Sinking  Fund  requirements  for  20 
years,  on  a  3%  basis,  the  decimal  for  $1 
being  .038654  $734,426 

$1,000,000  at  3%  for  20  years,  interest 600,000 

Cost  of  loan,  Sinking  Fund  Method   $1,334,426 

$1,000,000  20  year  Serial  Bond,  1-20,  or  50,OCO 

payable  yearly   $1,000,000 

Interest  (annually  diminishing)  total  at  3%..      315,000 

Cost  of  loan,  Serial  Bond  method $1,315,000 


Difference  in  cost  in  favor  of  Serial  Bond  method. .         $      19.426 
Alfred  D.  Chandler,  The  Metropolitan  Debts  of  Boston  and  Vicinitu 
(1905),  p.  73. 


CIVIL  DEBT  603 

have  its  own  sinking  fund  which  should  provide  for  both  prin- 
cipal and  interest  payments,  and  all  requirements  covering 
the  operation  of  the  sinking  fund  should  be  carefully  stated. 

Repudiation  of  Debt. — The  first  essential  in  obtaining  a  dis- 
criminating knowledge  of  civil  obligations  is  a  historical  per- 
spective of  civil  debts.  The  necessity  for  this  is  illustrated  by 
the  states  whose  credits  are  still  affected  by  the  repudiation  of 
their  debts  fifty  and  seventy-five  years  ago.1  While  it  is  highly 
improbable  that  any  state  or  group  of  states  or  other  civil  divi- 
sion will  repeat  the  indiscriminate  defalcation  or  repudiations 
practiced  fifty  to  seventy-five  years  ago,  it  must  not  be  for- 
gotten that  the  states  (not  minor  civil  divisions  of  the  state) 
still  possess  this  power  and  that,  with  two  or  three  exceptions, 
the  repudiation  of  state  debts  was  always  on  the  grounds  of 
illegality,  a  claim  against  which  the  investor  has  no  recourse.* 
When  considering  the  probable  future  action  of  a  state  in  a 
stringency  or  crisis,  the  only  criterion  we  are  warranted  in 
accepting,  is  its  action  in  the  past.  It  must  also  be  borne  in  mind 
that  many  commonwealths  of  the  Union  are  still  in  compara- 
tively early  stages  of  development,  and  to  classify  the  securities 
of  these  states  with  those  of  long  tested  commonwealths  like 
Massachusetts  and  New  York  shows  lack  of  appreciating  the 
necessity  of  "seasoning"  in  securities.  The  only  way  in  which 


JA  comprehensive  study  of  state  repudiations  is  W.  A.  Scott's, 
Repudiation  of  State  Debts  (1893). 

A  good  summary  is  contained  in  William  L.  Raymond's  American 
and  Foreign  Investment  Bonds  (1916),  chap.  iii.  pp.  94-139;  Lawrence 
Chamberlain,  Principles  of  Bond  Investments  (1911),  pp.  122-138  and 
the  United  States  Census  Report  on  State  Debt  (Census  of  1890). 

2On  the  basis  of  the  economic  influences  causing  repudiation,  the 
states  repudiating  their  debts  fall  into  three  periods;  (a)  The  default- 
ing in  the  period  1835-1845  in  which  Arkansas,  Florida,  Illinois.  In- 
diana. Maryland,  Michigan,  Mississippi,  and  Pennsylvania  repudiated, 
were  due  to  either  an  over-extension  of  internal  improvements  or  the 
excessive  support  of  state  banks  and  railroads;  (b)  In  the  second  period 
(1845-1800)  while  the  causes  were  similar  to  those  in  the  first  period, 
the  specific  repudiation  was  caused  by  an  arbitrary  readjustment  of 
debts.  This  period  of  repudiations  included  California,  Minnesota  and 
Texas;  (c)  In  the  third  period  (1865-1895)  in  which  the  long  list  of 
Southern  states  is  found,  repudiation  was  largely  due  to  a  disregard  of 
the  obligations  created  under  the  "carpet-bag  government"  following  the 
Civil  War.  These  states  were  Alabama.  Arkansas,  Florida,  Georgia, 
Louisiana.  Missouri.  North  Carolina,  South  Carolina,  Tennessee,  and 
Virginia. 


604  INVESTMENT  ANALYSIS 

this  "seasoning"  can  occur  with  any  class  of  securities  is 
through  experience.  This  historical  experience,  of  course,  must 
not  be  confounded  with  variations  which  occur  among  these 
states  in  their  financial  position  due  to  the  stage  of  development 
and  amount  and  varieties  of  their  resources  and  industries. 
Other  things  being  equal,  this  must  always  be  a  factor  which 
influences  the  difference  in  state  credit. 

Many  writers,  on  the  other  hand,  undoubtedly  have  over- 
emphasized the  importance  of  the  repudiation  of  state  debt 
which  occurred  fifty  and  seventy-five  years  ago.  In  a  large 
measure,  at  least  in  some  of  the  states,  the  stigma  of  repudia- 
tion has  been  lived  down  by  the  subsequent  policy  pursued  by 
the  state.  While  marked  distinction  must  be  made  between 
wilful  repudiation  and  unavoidable  defalcations,  it  is  radically 
unfair  to  assume  that  the  same  financial  policy  propagated  by  an 
over-zealous  improvement  party  in  the  interests  of  a  ' '  carpet-bag 
government"  will  be  followed  by  the  state  governments  after 
a  period  of  seventy-five  years.  But  no  one  will  deny  the  in- 
fluence repudiation  has  had  and  still  has  on  the  credit  of  those 
Southern  states  where  repudiation  took  place  and  no  readjust- 
ment has  been  made.  This  does  not  deny,  however,  the  neces- 
sity of  safeguarding  against  a  recurrence  of  delinquency  to- 
ward all  forms  of  obligations.1 

However,  a  historical  study  especially  of  county  and  munici- 
pal repudiated  issues  is  instructive  from  the  standpoint  of  what 
it  teaches  us  to  avoid.  The  total  of  municipal  repudiations  as 
compared  to  state  repudiations  is  relatively  small.  The  reason 
for  this  is  easy  to  explain.  Municipal  financing  in  the  newer 
and  rural  states  of  the  Middle  West  and  South  had  not  reached 
very  large  proportions  until  after  state  repudiation  was  a 
thing  of  the  past.  With  the  passing  of  state  repudiation,  the 
attitude  toward  repudiation  entirely  changed,  and  it  is  indeed 
rare  for  a  municipality  to  attempt  repudiation — it  is  fatal  to 
credit  and  this  is  now  appreciated. 

Of  the  bonds  repudiated  and  still  outstanding  there  is  not 
only  no  effort  but  not  even  a  desire  to  pay.  And  it  is  unlikely 


JSee  Legality  and  Validity  for  more  complete  discussion. 


CIVIL  DEBT  605 

that  these  issues  long  ago  repudiated  will  ever  be  paid.  As  al- 
ready mentioned,  illegality  of  issue  is  usually  advanced  as  a 
cause  of  repudiation,  but  with  only  rare  exceptions  the  funda- 
mental cause  has  been  the  inability  to  pay.1  This  is  revealed 
in  the  brief  summary  of  the  causes  of  municipal  bond  repudia- 
tion given  by  Mr.  Raymond:1 

"The  principal  causes  of  default  in  the  bonds  of  counties, 
municipalities,  and  districts  have  been:  .  .  .  1.  A  furor  for 
improvements  similar  to  that  which  prevailed  at  one  time  in 
many  of  our  states  and  which  led  to  financial  difficulties  at  one 
time  or  another  in  such  cities  as  Pittsburg,  Pennsylvania ;  Eliza- 
beth, New  Jersey;  and  Superior,  Wisconsin.  2.  Issue  of  rail- 
road-aid bonds  or  bonds  for  other  doubtful  or  illegal  purposes  as 
in  the  cases  of  Macon  County,3  Missouri ;  St.  Clair  County,  Mis- 
souri ;  Green  County,  Kentucky ;  Taylor  County,  Kentucky,  and 
Otoe  County  (Nebraska  City  Precinct),  Nebraska.  3.  Issue  of 
bonds  by  small,  struggling,  or  unstable  communities  where  the 
property  and  taxing  power  proved  insufficient  to  take  care  of  the 
bonds,  as  in  the  cases  of  Syracuse,  Kansas;  Olympia,  Washing- 
ton; Middlesboro,  Kentucky,  and  Mobile,  Alabama.  4.  Special 
misfortunes  such  as  yellow  fever  epidemics  in  Memphis,  Ten- 
nessee, and  Savannah,  Georgia,  and  the  disastrous  floods  at  Gal- 
veston,  Texas.  5.  Issue  of  bonds  by  municipal  irrigation  dis- 
tricts, where  the  inherent  risk  of  the  enterprise  is  considerable, 
such  as  Denver-St.  Vrain  Municipal  Irrigation  District,  Colo- 
rado, Denver-Greeley  Irrigation  District,  Colorado,  and  San 
Arroya  Irrigation  District,  Colorado." 

Projects  of  this  latter  character  are,  however,  hardly  worthy 
of  the  name  municipal.  They  strictly  belong  to  the  speculative 
and  promotional  class  of  undertakings. 


*M.  B.  Dean,  Municipal  Bonds  Held  Void  (1911),  p.  122.  This  gives 
one  of  the  most  complete  catalogues  of  the  repudiation  of  municipal 
bonds  up  to  its  original  date  of  issue  which  has  been  so  far  published. 

'William  L.  Raymond,  American  and  Foreign  Investment  Bonds, 
1916,  pp.  154-155. 

3The  Macon  County  issue  was,  as  has  been  the  case  in  other  issues, 
compromised.  And  it  must  be  frankly  said  that  some  of  these  commu- 
nities have  been  sinned  against  as  much  as  they  have  themselves  sinned. 
In  some  cases  owners  have  bought  them  with  the  full  knowledge  of  their 
irregularities  with  the  hope  of  large  profits.  This  however,  does  not 
imply  any  excuse  for  the  strict  accountability  of  the  municipality  in 
compliance  of  the  law,  though  both  sides  of  the  case  should  be  known 
to  enable  one  to  pass  judgment.  (Author's  comment.) 


CHAPTER  XXXVI 


SPECIAL   FACTORS   AFFECTING   THE   MARKET   AND 
PRICE  OF  CIVIL  OBLIGATIONS 

A  great  deal  of  apprehension  has  been  expressed  during  the 
last  twenty  years  over  the  growth  of  municipal  indebtedness.1 
The  increase  of  indebtedness  has  no  doubt  in  some  cities  been 
out  of  proportion  to  the  growth  in  population,  though  too  much 
significance  has  often  been  given  to  such  comparisons.  As  cities 
increase  in  size,  costs  necessarily  must  increase  at  a  more  rapid 
ratio.  "It  requires,"  states  a  former  Ohio  Commission,  "but  a 
glance  at  the  appropriation  ordinances  of  our  cities  to  see  that 
as  population  increases  the  functions  of  government  become 
numerous,  complex  and  costly.  This  is  not  due,  at  least  in  any 
degree  to  an  artificial  demand  on  the  part  of  those  who  live 
in  cities,  but  is  due  to  a  compulsion  quite  as  irresistible  as  the 
forces  of  nature. "* 

That  the  costs  of  municipal  government  are  persistently 
tending  upward  is  shown  by  a  study  of  the  quintennial  census 
made  by  the  United  States  Census  Bureau,  of  the  cities  above 
30,000  population.  It  will  be  noted  from  the  table  given  in  the 


xThe  Commercial  and  Financial  Chronicle,  vol.  cxii,  p.  177, 
vol.  Ixxxviii,  p.  113,  vol.  xc,  p.  121,  show  sales  of  municipal  bonds  for 
1892  to  1909  and  vol.  cviii,  p.  187 
$103,084.000 

118,113.000 

145,733.000 

149,498,000 

152,846,000 

152,281,000 

250,754.000 


1898 
1899 
1900 
1901 
1902 
1903 
1904 
1905 


183,080,000 


,  |J.  -LO  1 

1906 

$201.743,000 

1914  ... 

$474,074.000 

1907 

227.643.000 

1915  ... 

498,557.000 

1908 

313.797.000 

1916  .  . 

457.140.000 

1909 

339,424,000 

1917  .  . 

451,278,000 

1910 

320,036,000 

1918  .  . 

296,520,000 

1911 

396,859,000 

1919  .  . 

691,518,000 

1912 

386,551,000 

1920  .  . 

670,034,000 

1913 

403,246,000 

=Bulletin  of  the  Ohio  Legislative  Reference  Department,  Report  of 
the  Committee  for  an  Investigation  of  Finances  of  Municipalities  (Col- 
umbus, February  3,  1915,  p.  13). 

606 


MARKET  FACTORS  607 

footnotes1  that  these  cities  have  had  a  35  per  cent  increase  in 
population  from  1902  to  1917,  while  the  per  capita  cost  of  gov- 
ernment has  increased  44  per  cent  and  the  total  cost  117  per 
cent.  This  is  explained  by  the  greater  number  of  civic  under- 
takings of  the  larger  cities.  This  comparison  of  expenditures 
and  growth  of  cities  over  30,000,  is  also  generally  applicable  to 
other  cities  and  towns  of  the  United  States.  It  is  not  likely  that 
the  slight  fall  of  $34.53  to  $33.26  in  per  capita  cost  from  1915  to 
1917  will  remain  permanent.  It  is  generally  assumed  that  this 
is  merely  a  reflection  of  the  temporary  check  given  all  munici- 
pal improvements  during  and  immediately  following  the  War. 
The  real  test  by  which  this  growth  in  municipal  expenditures 
and  indebtedness  should  be  measured,  is  in  relation  to  the  com- 
munity's growth  in  wealth.* 

After  all,  the  interest  of  the  investor  in  the  growth  of  mu- 
nicipalities is  in  the  effect  upon  the  security  of  his  bond,  the 
permanency  in  its  price,  and  the  net  yield.  If  wealth  accumu- 
lation and  income  have  increased  at  a  faster  rate  than  expendi- 
ture and  indebtedness,  the  ability  to  pay  these  obligations  has 
also  increased.  The  strong  position  which  municipal  bonds 
continue  to  maintain  would  substantiate  this  conclusion. 

The  Market. — A  very  insignificant  proportion  of  state  or 
municipal  bonds  is  ever  listed  or  sold  on  the  stock  exchange. 
They  are,  as  described  in  the  chapter  on  Negotiation  and  In- 
surance of  Securities,  purchased  in  blocks  by  the  Investment 


*(146  Cities)  Net  Governmental  Cost  Payments 
Year  Total  Per  Capita 

1917  $1,007.290,000  $33.26 

1915  996.061,000  34.53 

1913  912.390,000  32.46 

1911  863,996,000  32.25 

1909  761,562,000  30.33 

1907  691,071.000  29.91 

1905  561,772,000  25.57 

1903  514.189.000  24.74 

1902*  462,574,000  22.71 

(Financial  Statistics  of  Cities  in  the  United  States  Over  30.000, 
[1917]  p.  17.) 

(*Taken  from  1912  Census.) 

'The  Study  of  the  Cost  of  Government  In  Minnesota  sustains  this 
argument.  Edward  Van  Dyke  Robinson,  The  Cost  of  Government  in  the 
United  States,  The  Amei'ican  Economic  Review,  vol.  iii  (December, 
1913),  pp.  815-830. 


608  INVESTMENT  ANALYSIS 

Banker  and  retailed  across  his  counter.  While  these  bonds  may 
be  widely  distributed  by  the  banker,  they  are  usually  deposited 
in  safety  deposit  boxes  as  permanent  holdings.  Consequently 
little  activity  is  ever  experienced  in  these  issues  after  their 
original  purchase.  That  this  is  the  case  is  evidenced  by  the 
large  amount  of  institutional  purchases. 

The  breadth  of  the  distribution  of  state  bonds  depends  a 
great  deal  upon  the  size  of  the  issue;  and  of  municipal  bonds 
upon  the  size,  importance,  and  location  of  the  municipality.  A 
large,  well-known  municipality  will  not  only  have  a  wider  geo- 
graphical market,  but  the  demand  within  the  municipality  itself 
is  often  large  enough  to  absorb  a  moderate  sized  issue. 

Another  local  market  is  created  by  the  preference  of  trus- 
tees, savings  banks,  insurance  companies,  and  other  financial 
institutions  for  bonds  of  their  own  state  and  its  political  divi- 
sions. This  results  in  many  institutions  buying  these  issues. 
So  decided  is  this  preference  that  even  where  not  limited  to 
state  issues,  institutions  have  been  known  to  purchase  them 
when  they  might  have  made  an  equally  safe  investment  with  a 
higher  yield.  Some  state  bonds,  particularly  those  for  small 
amounts,  have  had  a  more  or  less  artificial  market  owing  to  the 
fact  that  the  state  sinking  fund  has  to  be  invested  in  state 
bonds.  In  a  few  cases,  where  states  have  issued  bonds  in  a 
strained  market,  they  have  maintained  the  market  by  purchas- 
ing a  large  part  of  the  issue  for  a  state  sinking  fund.  This  is 
much  like  taking  money  from  one's  right  hand  pocket  and 
putting  it  into  the  left.  This  market  for  state  bonds,  however, 
has  never  been  an  artificial  market  in  the  same  sense  as  the 
artificial  market  which  was  created  for  United  States  2  per 
cent  bonds  under  the  National  Banking  Law. 

A  study  of  the  states  which  include  the  more  important  so- 
called  metropolitan  areas,  indicates  that  the  cities  within  cer- 
tain distances  of  the  financial  centers  of  these  areas,  have  an 
advantage  over  the  more  remote  and  purely  rural  areas  in  the 
price  they  can  secure  for  their  bond  issues.  Communication 
facilities,  etc.,  as  well  as  the  size  of  the  municipality,  are  all 
factors  which  enter  into  determining  the  price  of  the  issue.1 


'The  details  of  this  study  will  be  published  at  a  later  date. 


MARKET  FACTORS  609 

Why  these  differences  in  price  exist  in  issues  of  the  same 
class  of  bonds  in  these  areas  is  often  difficult  to  explain. 

Qualifications  which  may  safely  be  allowed  the  individual 
purchaser  are  not,  however,  always  permissible  for  financial 
institutions  in  their  purchases.  For  example,  one  prominent 
New  York  Savings  Bank  has  adopted  the  following  rules 
for  the  purchase  of  other  than  direct  obligations  of  coun- 
ties and  municipalities:  It  purchases  no  road  bonds  except 
those  issued  by  states  and  counties,  and  those  issued  by  munici- 
palities of  a  certain  size.  This  rule  is  also  followed  in  the  pur- 
chase of  paving,  sewerage,  drainage,  and  levee  bonds.  If  the 
bonds  are  issued  by  a  special  tax  district  a  guarantee  of  the 
city's  complete  responsibility  for  these  issues  must  be  contained 
in  the  statutes.  All  paving  bonds,  as  well  as  other  special  im- 
provement bonds  must  come  well  within  the  life  of  the  improve- 
ment. All  paving  bonds,  for  example,  must  not  be  more  than 
ten  years  in  duration.  Bonds  issued  by  mining  towns,  or  towns 
dependent  on  one  industry,  are  accepted  only  in  very  rare  in- 
stances, and  a  school  district  must  be  within  city  limits  to  have 
its  bonds  considered.  Debt  limitations  rather  than  limitations 
on  the  tax  levy  or  rate  are  given  favor.  Debts  must  not  exceed 
10  per  cent  of  the  actual  valuation  of  property,  and  assessment 
of  property  values  of  one  thousand  dollars  per  capita  is  con- 
sidered adequate. 

A  number  of  writers  continue  to  place  great  emphasis  on 
the  extent  to  which  repudiations  of  the  past  influence  the  price 
of  civil  loans  today.  No  doubt  these  repudiations  and  espe- 
cially such  notorious  instances  as  that  of  St.  Clair  County,  Mis- 
souri, continue  to  exert  some  influence  on  the  price  of  these 
securities,  but  not  as  some  writers  would  have  us  believe  to  the 
extent  of  being  the  dominant  influence  in  determining  their 
price.  When  we  consider  how  different  are  the  present  day 
conditions  that  must  affect  the  price  of  bonds  issued  by  Massa- 
chusetts or  New  York,  and  Tennessee  or  Alabama,  we  realize 
that  there  is  little  foundation  for  most  of  the  sweeping  asser- 
tions made  except,  of  course,  in  the  case  of  the  old  repudi- 
ated bonds  themselves. 

Protection  to  the  Investor  in  Certification. — The  investor  in 


610  INVESTMENT  ANALYSIS 

securities  needs  special  protection  as  to  the  genuineness  of  his 
bond  instrument,  and  the  validity  of  the  issue.  As  regards  the 
first,  the  trust  company's  certification1  of  the  genuineness  of  the 
instrument  gives  protection  to  the  purchaser  against  forgery. 
While  this  latter  is  a  good  thing,  it  is  not  considered  essential 
by  many  bond  houses.  In  a  great  many  instances  registration 
by  the  State  Auditor  is  compulsory.2  As  to  the  second,  while 
the  bond  attorney  has  reduced  the  danger  of  invalidity  to  a 
minimum,  there  is  never  an  absolute  guarantee.  As  a  result 
it  is  often  essential  to  seek  the  court's  interpretation,  as  fre- 
quently because  of  faulty  legislation,  as  for  the  errors  of  officials 
in  issuing  bonds.  This  legislation  is  termed  faulty  in  the  sense 
that,  had  the  legislation  been  more  accurate  or  definite,  the  error 
in  issue  would  not  have  been  made.  Both  constitutional  and 
statutory  law  still  reveal  a  good  deal  of  confusion  in  the  dif- 
ferentiation of  economic  and  legal  principles.  A  growing  recog- 
nition of  this  essential  distinction  is  now  apparent,  and  with 
it,  a  number  of  the  early  difficulties  in  issuing,  experienced  be- 
cause of  faulty  legislation,  are  being  corrected  in  the  revision 
of  municipal  bond  laws. 

Where  small  legal  technicalities  and  economic  principles  or 
principles  of  justice  conflict,  the  courts,  as  previously  stated, 
have  recently  often  tended  to  evade  these  technicalities  and 
made  their  decisions  on  the  sounder  grounds  of  economic  jus- 
tice. The  lack  of  compliance  with  such  technicalities  as  proper 
advertising  or  voting  and  even  limitation  of  debt  has  been  set 
aside  by  the  courts3  on  the  ground  that  the  funds  have  been 


*See  Chapter  viii,  Registration,  Transfer  and  Assignment  of  Sec- 
urities. 

2When  definite  recommendations  are  advanced  in  regard  to  cer- 
tification, one  is  confronted  with  great  differences  of  opinion  among 
bankers.  Many  bankers  feel  that  the  records  of  the  local  issuing  unit 
are  sufficient  safeguard. 

*W.  H.  Harris,  The  Law  Governing  the  Issuing,  Transfer  and  Col- 
lection and  Validity  of  Municipal  Bonds  (1917).  See  index  for  numer- 
ous illustrations.  The  well-known  attempt  of  the  mayor  of  Atchinson, 
Kansas,  to  force  the  refunding  of  old  bonds  yielding  4%  to  5  per  cent 
into  4  per  cent  bonds  at  par  and  his  refusal  to  pay  off  the  maturing 
issues  is  one  of  the  best  recent  illustrations  of  a  court's  enforcement 
of  justice.  The  court  required  the  city  to  levy  a  tax  and  pay  the  bonds. 
Levison  vs.  Finney  No.  18,  934  Supreme  Court  of  Kansas.  (This  case 
never  came  to  a  final  hearing.) 


MARKET  FACTORS  611 

used  and  the  benefits  received,  and  the  issuing  political  division, 
therefore,  should  be  held  liable  and  taxes  be  levied  to  pay  off 
the  obligation. 

A  few  states  have  adopted  methods  of  certifying  the 
validation  by  a  guarantee  of  the  validation  of  the  bond  issues. 
Certification  of  the  validation  of  an  issue  though  not  a  com- 
plete corrective  of  the  present  short-comings  of  financing  civil 
bans,  especially  municipals,  is  a  long  step  forward.  Like  all 
reforms,  this  one  is  slow  in  developing,  and  no  definite  form  of 
procedure  has  as  yet  been  adopted,  in  the  methods  of  certifi- 
cation. 

Some  of  the  Canadian  provinces  have  dealt  most  effectively 
with  the  certification  of  civil  loans.  While  the  administration 
of  certification  is  vested  in  different  bureaus  or  departments 
of  government,  the  principle  involved  is  the  same  in  all  cases. 
In  the  Province  of  Ontario,  the  Ontario  Railway  and  Municipal 
Board;  in  the  Province  of  Manitoba,  the  Municipal  Commis- 
sioner; in  the  Province  of  Alberta  and  Saskatchewan,  the  Min- 
ister or  Deputy  Minister  of  Municipal  Affairs;  in  the  Province 
of  British  Columbia,  the  Inspector  of  Municipalities;  in  the 
Province  of  Nova  Scotia,  the  Commissioner  of  the  Municipal 
Sinking  Fund,  and  in  the  Province  of  New  Brunswick,  the 
Auditor  General,  have  the  power  to  certify  municipal  loans.1 
These  laws  which  have  worked  with  admirable  success  and  have 
had  a  perceptible  effect  on  lessening  the  cost  of  financing  these 
issues  are  worthy  of  emulation. 

Long  before  any  very  serious  thought  was  given  in  the 
United  States  to  the  state's  certification  of  its  own  municipal 
loans,  North  Dakota  adopted  (1889)  a  constitutional  measure 
which  requires  that  the  bond  issues  of  the  state  or  its  political 
divisions  shall  be  certified  by  the  State  Auditor  "showing  that 
the  bond  or  evidence  of  debt  is  pursuant  to  law  and  within  the 
debt  limit."  Likewise,  the  bond  issue  of  a  minor  civil  division 
to  be  made  valid,  "shall  have  indorsed  thereon  a  certificate 


1E.  G.  Long  (member  of  Ontario  Bar),  Pamphlet  on  Canadian  Mu- 
nicipal Bonds,  a  synopsis  of  laws  governing  issues  (published  by  Brent 
Norton  &  Co..  Toronto.  Ontario). 

'Constitution  of  North  Dakota,  Art.  XII,  Sec.  1ST. 


612  INVESTMENT  ANALYSIS 

signed  by  the  county  auditor,  or  other  officer  authorized  by 
law  to  sign  such  certificate."  With  this  certification  no  con- 
test can  be  made  of  the  validity  of  the  issue,  though  it  has  no 
effect  on  the  power  of  the  state 's  authority  to  resist  the  payment 
of  any  debt,  if  it  wills,  i.  e.,  its  power  of  supreme  sovereignty 
is  not  overcome  by  its  own  constitution. 

The  statutes  of  Texas1  require  the  approval  of  the  Attorney 
General,  and  no  bonds  can  be  issued  without  his  approval.  The 
latter  law  goes  into  greater  particulars  as  to  the  detailed  evi- 
dence of  the  right  of  issue  to  be  presented  to  the  state  official 
than  does  the  North  Dakota  requirement  of  certification.  In 
this  respect  the  criticism  previously  directed  against  the  lack 
of  the  economic  justification  of  the  bond  issue  can  to  some  extent 
be  forced  upon  the  issuing  political  division  by  state  officials, 
but  it  is  still  quite  incomplete. 

Similar  clauses  requiring  certification  or  approval  of  minor 
civil  division  bonds  have  been  included  in  the  state  constitutions 
of  Kansas,2  Nebraska,3  and  Oklahoma,4  and  the  statutes  of  West 
Virginia5  and  Colorado8  (applies  the  certification  to  refunding 
issues  of  municipalities),  New  Jersey  limits  its  validation  to 
school  bonds,  which  must  be  passed  by  the  Attorney  General 
of  the  state,7  and  no  question  of  validity  can  be  raised  "after 
the  lapse  of  twenty  days  from  the  first  publication  of  the  ordi- 
nance." North  Carolina,8  whose  law  is  similar  to  that  of  New 
Jersey,  limits  the  period  of  protest  of  validity  to  thirty  days. 

The  statutes  of  the  state  of  Georgia9  have  gone  further  than 
those  of  any  other  state  in  giving  the  power  of  reviewing  a 
municipal  loan.10  After  a  municipality  has  approved  of  the 
bond  issue  by  vote,  the  Attorney  General  files  all  the  evidence 


'Texas  Acts  of  1895,  p.  1894;   Acts  1901,  p.  16,  Revised   Statutes 
Title  XVIII,  Art.  619-625. 

"Kansas.  General  Statutes  for  1915. 
'Nebraska,  Constitution,  Art.  XII,  Sec.  2. 
'Oklahoma,  Constitution,  Art.  X,  Sec.  29  (1907). 
"West  Virginia,  Statutes  3917,  chap.  Mi. 
"Colorado.  Statutes  of  1909. 
TXew  Jersey.  The  Pierson  Bond  Act,  1916. 
"North  Carolina  Public  Laws.  1917,  chap,  cxxxviii. 
"Georgia  Acts,  1897,  p.  82,  Code  of  1911,  Sec.  445,  457. 
"Sustained  by  Supreme  Court  of  State  December  1,  1908. 


MARKET  FACTORS  613 

pertaining  to  the  issue  with  the  Clerk  of  the  Superior  Court 
together  with  a  petition  asking  for  its  validation. 

Massachusetts1  has  made  use  of  the  certification  in  an  en- 
tirely new  way  by  applying  it  to  current  or  floating  loans  of 
the  municipality. 

The  Purpose  of  Issue  vs.  Market  and  Price. — No  very  com- 
plete study  has  ever  been  made  of  the  effect  which  the  purpose 
of  the  issue  has  on  either  the  validity  or  market  price  of  civil 
bonds.  Not  only  the  enormousness  of  the  task  but  the  complex- 
ity of  the  problem  has  been  a  serious  obstacle  to  its  undertak- 
ing. It  is  hoped  that  some  large  municipal  bond  house  will 
some  day  undertake  it  as  a  contribution  to  the  science  of  in- 
vestment bonds.  The  different  purposes  referred  to  here  should 
not  be  confused  with  the  differences  existing  among  the  same 
classes  of  issues  made  by  the  various  civil  jurisdictions.  For 
example,  on  the  face  of  it,  a  bridge  bond  issued  by  a  county 
should  sell  at  a  higher  price  than  a  bond  issue  for  the  same 
purpose  issued  by  a  special  assessment  district.  But  why 
should  a  difference  in  yield  exist  between  a  bond  issued  by  a 
township  for  a  school  building  and  one  for  roads  if  both  bonds 
are  a  general  claim  against  the  township? 

Differences  in  the  powers  and  the  claims  granted  by  constitu- 
tions and  statutes  to  an  issuing  political  unit  will  explain  many 
of  these  differences  in  prices,  but  by  no  means  do  they  account 
for  all  those  slight  fractional  differences  in  return  which  are 
of  such  importance  in  the  purchase  of  the  highest  grade  securi- 
ties. Again,  it  is  obvious  why  there  should  be  a  difference  in 
price  between  serial  payment  bonds  and  special  assessment 
bonds,  due  in  a  single  payment,  or  why  a  difference  in  price 
should  exist  between  a  special  assessment  and  a  county  bond. 
But  why  should  a  difference  exist'  between  issues  which  hold  the 
same  claim  against  the  county? 

One  explanation  which  accounts  for  and  is  the  reason 
for  the  lack  of  any  extended  and  critical  examination  of  the 
varying  prices  of  municipal  bonds,  is  the  fact  that  they  are 


'Massachusetts,  Acts  1010.  p.  616 ;  Amended  1912,  chaps,  xlv  and  xlix. 
Also  Acts  1915,  chaps.  Ixxxiv  and  cclxxxv. 


614  INVESTMENT  ANALYSIS 

subject  to  the  wide  and  varied  influences  of  the  money  market, 
as  distinct  from  the  so-called  internal  influences.  As  stated  in 
the  chapters  on  Market  Influences,  the  highest  grade  bonds  are 
the  most  sensitive  to  any  changes  of  market.  These  changes,  of 
course,  are  not  the  large  variations  in  prices  normally  thought 
of  in  the  speculative  market.  They  are  very  slight,  often  affect- 
ing the  rate  of  return  only  fractionally,  but  they  are  important, 
nevertheless,  as  a  specific  rate  of  return  is  frequently  the  de- 
terminant in  the  purchase  of  high  grade  investment  securities. 
Denomination  and  Duration. — Civil  obligations  come  in 
denominations  as  low  as  $25,  though  the  more  generally  accepted 
denominations  are  the  $500  and  $1,000  coupon,  registered  and 
interchangable  bonds,  but  all  three  may  not  be  found  in 
the  same  issue  or  the  same  state.  Larger  denominations  which 
necessarily  have  an  inactive  market  are  usually  registered. 

The  duration  of  state  bonds  varies  from  six  months  in  the 
temporary  loans  of  Louisiana  to  the  century  bonds  of  the  state 
of  Virginia.  The  average  duration,  if  an  average  can  be  said 
to  exist,  is  about  twenty-five  years.  State  bond  issues  until  ten 
years  ago  were  very  few.  This  condition,  as  pointed  out  earlier, 
has  changed,  as,  for  example,  large  and  relatively  frequent 
issues,  have  been  made  for  roads.  New  demands  are  conse- 
quently beginning  to  appear  for  changes  in  constitutions  and 
laws  affecting  state  issues.  The  majority  of  the  regulations 
affecting  the  details  of  state  issues  are  those  of  an  earlier  period. 
Of  the  long  termed  municipal  securities  the  range  in  dura- 
tion of  township,  county,  city  and  town  bonds  is  from  one  to 
forty  years.  Securities  issued  on  the  serial  plan  are  from  one 
to  twenty-five  years.  This  range  in  duration  is  also  true  of  spe- 
cial assessments,  with  the  exception  of  special  assessment  issues 
in  large  cities  which  range  from  one  to  ten  or  fifteen  years. 

The  majority  of  laws  regulating  the  bonds  issued  by  the 
states  require  a  sinking  fund.  This  is  true  in  some  instances 
even  where  the  local  governments  of  the  states  are  required 
to  use  the  serial  form  of  payment.  The  costliness  of  this 
method  of  financing  has  already  been  spoken  of  and  no  fur- 
ther reference  need  be  made  to  it.  Among  the  older  states, 
Maine  and  West  Virginia  require  the  serial  method,  while  one 


MARKET  FACTORS  615 

or  two  other  states  alloy/  a  choice  of  either  one.  All  the  bonds 
issued  by  New  York  State  from  1890  to  1902,  except  the  canal 
bonds,  were  serial  bonds.  Sixteen  states  have  provisions  for 
sinking  funds  but  have  accumulated  no  sinking  funds.  In  some 
instances  there  is  no  need  of  a  sinking  fund  as  no  debt  is  out- 
standing. Only  two  of  the  Southern  states  that  have  sinking 
fund  provisions  have  accumulated  any  sinking  fund.  The  most 
common  regulation  for  the  accumulation  of  a  sinking  fund  is 
the  collecting  of  a  definite  amount  per  annum,  as  in  Ohio,  or  a 
given  rate  of  mills  per  dollar  of  tax  as  in  Arkansas.  Montana 
provides  for  six  sinking  funds  from  the  proceeds  of  land  sales. 
New  Jersey,  though  it  has  only  a  very  small  debt,  goes  to  the 
extent  of  providing  that  the  sinking  funds  may  draw  on  the 
state  treasury  temporarily  for  deficiencies.  California  accumu- 
lates a  sinking  fund  from  fees  paid  to  the  Harbor  Commis- 
sioners, and  invests  the  proceeds  in  United  States  bonds. 
These  illustrations  are  indicative  of  the  lack  of  uniformity  in 
these  state  funds.  Even  the  amounts  are  of  little  significance 
at  the  end  of  any  fiscal  year,  as  the  fund  may  be  in  several 
different  forms  which  are  not  usually  indicated  in  the  state 
reports.  The  tendency  in  the  municipal  issues  of  the  last  ten 
years,  as  pointed  out  under  the  topic  of  Sinking  Fund  vs.  Serial 
Payments  in  the  chapter  on  the  Civil  Debt,  has  been  toward 
the  adoption  of  the  serial  payment  plan.  In  this,  the  only  im- 
portant requirement  is  that  the  retirement  of  bonds  created  for 
improvements,  such  as  road  and  paving  bonds,  shall  be  well 
within  the  life  of  the  improvements.  In  relation  to  the  serial 
payment  plan,  it  might  be  added  that  important  dealers  in 
municipal  securities  are  almost  uniformly  in  favor  of  serial 
payment  and  have  done  very  much  to  induce  communities  to 
change  their  method  of  financing  in  this  respect. 

The  refunding  privilege  which  is  not  ordinarily  used  for 
civil  obligations  has  been  used  by  a  few  municipalities.  In 
some  states  this  practice  is  denied  by  law,  and  as  before  stated, 
it  is  a  serious  question  as  to  whether  it  should  be  allowed  in 
municipal  financing.  In  states  where  some  of  the  early  issues 
of  very  long  duration,  and  the  6  and  7  per  cent  irredeemables 
of  the  seventies  and  eighties  are  found,  the  refunding  privilege 


616  INVESTMENT  ANALYSIS 

makes  it  possible  for  the  municipality  to  take  advantage  of 
better  market  rates.  If  the  length  of  municipal  bonds  were 
reduced,  this  advantage  would  be  at  least  partially  offset,  and  a 
check  would  exist  against  municipal  extravagances. 

Bonds  subject  to  call  may  be  called  in  whole  or  in  part  upon 
any  interest  payment  date.  Where  callable  privileges  are  prac- 
ticed, the  procedure  is  followed  throughout  the  locality  or  state. 
This  privilege  gives  a  municipality  the  advantage  of  refunding 
an  issue  in  that  it  can  retire  an  outstanding  issue  which  carries 
a  high  rate.  The  call  feature  on  municipal  bonds,  however,  is 
frowned  upon  by  municipal  bond  dealers.  The  feeling  is  that 
the  safest  policy  for  a  municipality  is  to  adhere  to  a  rigid  final 
retirement  of  an  obligation.  If  call  features  are  attached,  the 
present  strong  structure  of  municipal  financing  will  be  open  to 
possible  abuse  by  politicians. 

The  successful  experience  of  the  Federal  government  in  its 
issue  of  postal  savings  bank  bonds  of  small  denomination,  as 
well  as  the  Liberty  bond  issues,  has  emphasized  the  existence  of 
an  extensive  field  for  investment  funds  which  has  been  little 
cultivated  in  this  country.  Once  our  machinery  for  the  distri- 
bution of  small  denomination  bonds  is  perfected,  eliminating  the 
present  obstacle  of  high  costs,  this  market  for  municipal  bonds 
of  small  denominations  should  have  a  very  rapid  expansion. 
The  limited  knowledge  of  municipal  as  compared  to  Federal 
bonds  possessed  by  the  group  of  people  to  whom  these  invest- 
ments should  appeal,  can  easily  be  remedied,  and  a  permanent 
popularity,  such  as  is  necessary  in  order  to  establish  a  perma- 
nent market  for  small  denominations,  can  be  established  for 
these  loans.  This  is  particularly  true  of  civil  bonds,  because 
of  the  small  margin  of  profits  realized  by  the  banker  under- 
writing the  issue.  Their  profits  have  been  made  possible  by 
the  sale  of  municipal  issues  in  large  blocks. 

Civil  Loans  as  Collateral — Their  Convertibility. — One  of  the 
necessary  requirements  of  a  high  grade  security  is  that  it  be 
acceptable  as  collateral  for  loans.  Civil  obligations,  as  a  class, 
are  not  excelled  by  any  other  class  of  securities  either  in  the 
amount  of  the  loan  or  the  interest  paid  for  the  loan.  To  large 
investors  this  has  been  a  particularly  desirable  feature. 


MARKET  FACTORS  617 

The  functions  of  commercial  banks  make  it  necessary  that 
their  investments  be  particularly  safeguarded  as  to  safety  of 
principal  and  that  they  possess,  as  well,  a  very  high  degree  of 
convertibility.  These  funds  are  invested  for  the  purpose  of 
creating  a  reserve,  which,  in  case  of  emergency,  can  be  readily 
liquidated  and  drawn  on  to  keep  the  reserve  fund  of  the  bank 
at  a  normal  level.  Next  to  two  named  discount  papers  no  form 
of  securities  fulfills  the  requirements  of  this  secondary  reserve 
as  well  as  do  civil  obligations. 

While  convertibility  is  not  necessary  to  the  same  extent 
with  savings  banks  reserves,  and  even  less  so  with  those  of  in- 
surance companies,  safety  and  stability  in  price  must  be  had. 
Savings  banks,  though  they  are  from  time  to  time  forced  to  make 
a  large  liquidation,  normally  carry  most  of  their  funds  in  per- 
manent investments,  as  these  bring  the  largest  returns.  State 
laws  have  as  a  consequence  laid  down  fairly  definite  require- 
ments for  the  investments  of  savings  banks  and  insurance  com- 
panies. Some  states  have  even  gone  to  the  extent  of  requiring 
that  the  investment  be  in  local  civil  bonds  of  the  state.  Not- 
withstanding the  serious  objection  to  a  statute  of  this  char- 
acter, civil  obligations,  as  a  class,  have  fulfilled  these  require- 
ments more  fully  than  securities  of  any  other  class. 

In  all  of  the  Federal  government's  dealings  with  national 
banks,  state  and  municipal  bonds,  certificates  and  warrants, 
after  Federal  bonds,  have  always  been  accepted  as  the  most 
desirable  securities  for  deposits  of  government  funds;  and  a 
wide  acceptance  of  state  and  municipal  bonds,  as  securities  for 
emergency  currency  was  made  under  the  former  Aldrich  and 
Vreeland  statute.  Though  the  Federal  Reserve  Banking  law 
has  changed  depository  requirements,  the  law  still  requires  for 
particular  purposes  that  Federal,  state,  and  municipal  bonds  be 
offered  as  security.1  These  bonds  also  find  a  market  through 
their  acceptance  as  collateral  under  the  Federal  Farm  Loan*  Act 
and  Postal  Savings  Acts." 


*The  Federal  Reserve  Act  a.*}  amended  (1920),  see  particularly  Sec- 
tions 12-18. 

'Federal  Farm  Loan  Act,  Section  6. 
•Amendment  to  Postal  Savings  Bank,  Section  2. 


618  INVESTMENT  ANALYSIS 

Another  use  of  the  Federal  bonds,  discussed  more  com- 
pletely in  a  subsequent  chapter,  is  the  employment  of  the  two 
per  cents  as  security  for  national  bank  note  circulation.  Under 
the  Federal  Keserve  Act,  the  national  banks  can  continue  the 
circulation  of  their  bank  notes  on  the  basis  of  the  regulations 
of  the  old  law,  or  if  the  national  banks  give  up  their  privilege, 
a  similar  one  can  be  exercised  by  the  Federal  Reserve  banks. 

Tax  Exemption. — Prior  to  the  entrance  of  the  United  States 
into  the  European  War  all  United  States  bonds  were  tax 
exempt,  and  the  exemption  of  the  principal  of  the  bond  from 
taxation  still  continues  where  an  income  exceeds  the  amount 
privileged  to  exemption  under  the  Federal  Income  Tax  Law. 
The  return  from  Liberty  Loan  issues,  under  certain  conditions, 
is  subject  to  taxation.1  This  limited  exemption  privilege  on  all 
but  the  First  Liberty  Loan  3~y2s  and  3%s  as  shown  in  the  fluc- 
tuation of  the  market  price  of  the  Liberty  Loans,  has  had  a 
marked  effect  in  the  price  of  all  these  issues : 

"This  change  in  the  total  tax  exemption  of  United  States 
bonds  is,  no  doubt,  the  result  of  the  movement  started  by  those 
who  have  seriously  questioned  the  exemption  of  civil  bonds  as 
a  class.  While  the  Federal  government  might  tax  all  future 
bond  issues  directly  or  make  them  subject  to  the  income  tax, 
it  cannot  tax  the  bond  issues  of  the  state  or  any  of  its  minor 
civil  jurisdictions.  .  .  .  The  consensus  of  opinion  of  practically 
all  of  those  attorneys  who  may  be  regarded  as  experts  on  ques- 
tions of  Constitutional  Law  is  that  the  Federal  government  is 
without  power  to  legally  impose  taxes,  either  directly  or  indi- 
rectly, on  the  income  from  obligations  of  states  and  their  sub- 
divisions and  that  the  various  decisions  of  the  United  States 
Supreme  Court  indicate  clearly  that  if  that  court  is  called  upon, 
to  decide  the  matter,  ...  it  would  declare  such  legislation 
(to  tax  municipal  issues)  unconstitutional.  Aside  from  the 
legality  of  such  action  is  the  fact  that  the  Sixteenth  Amend- 
ment, which  provides  the  authority  for  the  Federal  Income  Tax, 
as  it  now  exists,  was  ratified  by  the  states  with  the  distinct 
understanding  that  no  such  power  was  sought  or  intended ;  and 
it  is  therefore  clear  that  the  Federal  government,  if  it  desires 
to  impose  such  taxation,  should  secure  the  authority  for  the 


'For  the  details  of  the  tax  exemption  privileges  allowed  on  all 
Liherty  Loan  issues,  see  the  table  of  C.  F.  Childs  &  Company,  of  Chicago, 
in  Appendix  C, 


MARKET  FACTORS  619 

same  through  the  medium  of  a  properly  ratified  amendment, 
clearly  setting  forth  such  power. ' ' 1 

While  this  statement,  in  light  of  the  decisions  of  the  Supreme 
Court,  seems  to  be  beyond  all  dispute,  is  an  amendment  to  our 
Federal  constitution  requiring  the  taxation  of  the  bonds  of  all 
civil  divisions  likely  within  the  next  decade?  A  considerable 
agitation  for  a  more  general  taxation  of  bond  holdings  devel- 
oped in  certain  quarters  during  the  War,  and  should  this  agita- 
tion continue  and  grow,  it  will  command  immediate  attention 
and  consideration. 

Development  of  this  agitation  for  the  taxing  of  all  civil  loans 
is  interesting  in  light  of  the  fact  that  there  has  been  a  growing 
tendency  the  last  fourteen  years  to  exempt  especially  municipal 
bond  issues  from  taxation.  With  the  exception  of  the  statutes 
of  seven  states,  all  the  present  exemption  statutes,  granting  com- 
plete exemption  to  municipal  bonds  of  the  issuing  state,  have 
been  passed  since  1905  and  the  greatest  increase  has  been  since 
1910.  But  should  this  agitation  for  taxation  continue,  it  must 
not  be  forgotten  that  there  is  every  evidence  in  the  application 
of  such  a  tax  that  the  price  of  the  security  must  be  effected 
or  the  municipality  pay  a  higher  rate  of  interest.  With 
securities  yielding  a  low  rate  of  return  this  is  of  special  sig- 
nificance, as  the  most  important  purchases  of  these  securities 
have  been  made  by  individual  investors  who  buy  in  large 
amounts;  and  since  income  taxes  are  levied  on  a  progressive 
rate,  the  result  is  apparent.  In  some  states,  as  mentioned  in 
the  chapter  on  the  Taxation  of  Securities,  there  is  a  registra- 
tion through  which,  upon  payment  of  a  reasonable  tax,  the 
securities  are  exempt  during  their  life,  regardless  of  owner- 
ship. 

Territorial  and  insular  bonds  have  enjoyed  the  same  rights 
of  tax  exemption  under  Federal  law  as  Federal  bonds  in  the 
territory  of  the  United  States.  The  municipal  territorial  bonds, 
concerning  which  legal  opinion  has  differed  as  to  their  taxabil- 


JReport  of  the  Committee  on  Municipal  Securities  (Howard  F. 
Beebe.  Chairman)  of  the  Investment  Bankers  Association,  I.  B.  A.  of  A. 
Bulletin.  October  1.  1918,  vol.  vii,  No.  2,  p.  24.  Also  see  Pollock  vs. 
Farmers'  Loan  Trust  Co.  157  U.  S. 


620  INVESTMENT  ANALYSIS 

ity,  in  a  recent  case  have  quite  definitely  been  placed  in  the 
non-taxable  list.1 

Other  exemptions  under  Federal  law  are  the  bonds  of  the 
Federal  Farm  Loan  Bank,  the  Joint  Stock  Land  Bank2  and  the 
War  Finance  Corporation  Bonds,  the  latter  being  only  a  war 
emergency  corporation.  The  character  of  the  bonds  of  the  two 
former  institutions  has  been  discussed  at  length  in  a  previous 
chapter.  State  bonds  are  likewise  exempt  from  all  Federal  taxes 
and  generally  are  made  exempt  by  the  state.  This  exemption, 
however,  does  not  extend  beyond  the  political  borders  of  the 
state  unless,  as  is  not  often  the  case,  specifically  allowed  by  the 
statutes  of  other  states. 

Of  the  minor  civil  tax  groups  those  most  favored  are  the 
city,  town  or  village.  Seventeen  states'  practically  exempt  all 
municipal  issues,  and  five  which  have  no  constitutional  or  tax 
law  affecting  municipals,  have  ruled  that  municipals  are  tax 
exempt.4  Other  states  exempt  municipals  under  special  condi- 
tions.5 For  illustration,  New  Hampshire  and  Wyoming  exempt 
municipals  when  held  by  citizens.  South  Carolina  exempts 
school  and  municipal  bonds  and  other  issues  by  a  special  legis- 
lative act.  Vermont  allows  exemption  to  certain  specified  issues 
with  a  rate  not  over  4  per  cent.  West  Virginia  allows  exemp- 
tion only  to  issues  held  by  banks.  In  Virginia  local  author- 
ities may  exempt  for  particular  purposes.  "All  bonds  issued 
by  Pennsylvania  municipalities,  counties  or  school  districts  in 
Pennsylvania  are  subject  to  a  state  tax  of  four  mills  which  is 


'Farmers  Bank  vs.  Minnesota,  1914,  232  U.  S.  516,  34  Sup.  Ct. 
Rep.  354. 

2See  chap.  xxxv. 

"Alabama,  California,  Connecticut,  Georgia.  Idaho,  Indiana  (certain 
issues  are  limited  as  to  rate),  Iowa  (banks  not  allowed  to  deduct  from 
shares),  Kansas,  Kentucky,  Maine,  Maryland,  Massachusetts.  Michigan. 
Minnesota,  New  Jersey,  New  York,  Washington.  (Commercial  and 
Financial  Chronicle,  State  and  City  Supplements  for  1919.) 

4According  to  the  opinions  of  state  attorneys  rendered  to  the  Com- 
mercial and  Financial  Chronicle  cited  in  the  supplement  referred  to 
above,  the  following  states — Delaware.  Nevada  and  Ftah — exempt  all  mu- 
nicipals. To  this  list  also  should  be  added  the  territorial  and  municipal 
issues  of  Arizona  and  New  Mexico. 

'Commercial  and  Financial  Chronicle,  State  and  City  Supplement, 
1919.  (The  detailed  references  to  the  statutes  have  not  been  cited,  as 
they  are  so  easily  available  in  this  standard  publication.) 


MARKET  FACTORS  621 

paid  by  the  political  unit  issuing  the  bonds  and  deducted  from 
remittance  of  interest  to  the  bond  holder  unless  the  bonds  are 
issued  'tax  free'  when  the  municipality  itself  assumes  the 
tax."  With  the  modifications  which  are  continually  being 
made,  especially  where  partial  exemption  rights  exist,  the  text 
of  the  statute  should  be  carefully  scrutinized.  Unless  court 
interpretation  has  been  made,  the  assumption  of  this  privilege 
may  be  open  to  question.  A  subsequent  denial  or  withdrawal 
of  a  privilege  already  accepted  or  exercised  would  have  more 
than  a  relative  influence  in  the  depreciation  of  the  price  of 
the  bonds. 

Any  exemption  lists  or  special  laws  affecting  the  taxation  of 
securities  of  a  state  and  its  minor  civil  division  soon  become 
obsolete.  The  lists  cited  are  chiefly  made  to  give  the  reader 
some  appreciation  of  the  extent  of  these  exemptions.  Prior  to 
1905  only  seven  states  granted  complete  tax-exemption  to  the 
securities  of  their  minor  civil  division.  Since  this  period  there 
has  been  a  decided  tendency  toward  exemption  from  state  tax. 
Whether  there  will  be  a  reversion  in  the  next  ten  years,  as 
already  suggested,  back  to  a  taxing  of  these  securities  is  still 
problematic. 


United  States  government  bonds,  prior  to  the  European 
War,  were  purchased  almost  exclusively  by  a  few  ultra-con- 
servative investors  and  national  banks.  The  return  on  these 
bonds  was  too  small  to  attract  the  average  purchaser  of  invest- 
ment securities.  The  greater  part  of  the  national  bonds  were 
held  by  the  national  banks,  it  being  possible  to  use  them  as  col- 
lateral to  secure  national  bank  notes,  otherwise  known  as  "cir- 
culation." In  1914  approximately  seven-ninths  of  the  outstand- 
ing United  States  bonds  were  held  by  national  banks  and  de- 
posited with  the  United  States  Treasurer  as  security  for 
national  bank  notes. 

The  Liberty  bonds  issued  during  the  European  "War,  how- 
ever, changed  the  investment  position  of  the  United  States 
bonds.  Because  of  the  amounts  to  be  raised,  higher  rates  of 
return  had  to  be  offered  to  secure  a  wide  distribution.  It  is, 
however,  well  known  that  the  appeal  to  patriotism  in  the  nation- 
wide campaigns  for  the  Liberty  issues  was  responsible  for  their 
wide  absorption.  The  higher  nominal  rate  and  the  even  higher 
net  yield  resulting  from  the  depression  of  the  price  of  Liberty 
bond  issues  following  the  close  of  hostilities,  together  with  the 
tax  exempt  privileges,  made  these  issues  particularly  desirable 
to  large  investors.  As  a  consequence,  the  greater  part  of  the 
Liberty  issues  were  transferred  within  the  course  of  a  very  few 
months  into  the  hands  of  large  investors.  But  while  the  greater 
part  of  these  securities  so  widely  distributed  during  the  period 
of  and  immediately  after  the  War  have  been  transferred  to  the 
larger  investors,  United  States  bonds  will  continue  to  have  a 
much  wider  investment  market  among  all  private  investors. 

Summary  of  the  History  of  the  United  States  Bonded  Debt. 
—When  Alexander  Hamilton  became  Secretary  of  the  Treas- 

622 


UNITED  STATES  BONDS  623 

ury  under  the  new  government,  he  found  an  empty  treasury  and 
no  credit  abroad.  But  with  the  authority  provided  under  the 
constitution,  Hamilton  negotiated  small  loans  from  one  of  the 
few  large  banks  to  pay  the  actual  running  expenses.  Congress 
also  provided  for  an  issue  of  securities — then  called  stock  after 
the  English  practice— of  about  $60,000,000,  of  which  $12,000,000 
was  to  be  applied  to  foreign  loans  and  $21,500,000  to  take 
domestic  loans.  The  total  debt  assumed  by  the  new  government 
was  $72,775,895,  of  which  $40,256,802  was  the  debt  of  the  Col- 
onial Confederation,  $12,556,874  loans  from  foreign  govern- 
ments and  $19,962,219  debts  of  the  respective  states.  The  gov- 
ernment debt  prior  to  the  War  of  1812  fluctuated  to  its  high 
point  in  1804  when  it  totalled  over  $86,427,120.  The  most  im- 
portant loan  during  this  period  was  the  $13,000,000  issued  in 
1803  for  the  Louisiana  purchase.  The  loan  negotiated  prior  to 
this  in  Holland  in  1798,  at  8  per  cent,  had  the  highest  nominal 
rate  ever  paid  on  a  United  States  bond  issue.  But  despite  the 
handicaps  of  the  new  government,  the  funded  obligation  under 
Hamilton's  Sinking  Fund  policy  had  been  reduced  by  1811  to 
$45,000,000.  In  1814,  however,  the  sound  financial  structure 
which  Hamilton  had  erected  was  almost  swept  away  and  pri- 
vate credit  was  not  less  demoralized. 

During  the  War  of  1812,  twelve  separate  loans  were  issued 
under  no  very  definite  financial  policy.  Rates  of  these  loans 
varied  from  5  2/5  to  7  per  cent.  During  this  period  a  distinc- 
tion was  made  for  the  first  time  between  a  government  bond 
and  a  treasury  note,  and  purchases  of  previous  issues  were  con- 
vertible into  subsequent  issues  which  possessed  more  favorable 
terms.  The  effect  of  the  latter  was  to  force  a  lowering  of  secur- 
ity prices,  and  as  a  result  some  of  the  later  loans  sold  at  a  dis 
count  from  12  to  as  low  as  35  per  cent.  The  total  loss  to  the 
government  in  discounts  approximated  $35,000,000.  By  Janu- 
ary 1,  1816,  the  debt  had  increased  to  a  total  of  $127,334,933. 
But  during  the  next  twenty  years  this  debt  was  paid  off  and 
a  surplus  of  $28,000,000  was  accumulated,  largely  from  the 
sale  of  lands  and  was  distributed  among  the  states. 

The  next  important  episode  in  this  history  was  the  panic  of 
1837  which  tied  up   the  government  funds  in   banks  and   so 


624  INVESTMENT  ANALYSIS 

depressed  business  that  the  important  sources  of  revenue  were 
cut  off.  This  led  to  a  number  of  note  issues  which  had  not  been 
fully  retired  when  the  Mexican  War  of  1847  again  augmented 
the  debt  of  the  country.  By  the  end  of  1860  the  gross  debt  of 
the  United  States  had  increased  to  $87,718,660. 

Following  the  opening  of  the  Civil  War  almost  every  avail- 
able form  of  credit  was  used  to  secure  funds.  Interest  rates 
varied  from  the  non-interest  bearing  demand  notes  to  rates  as 
high  as  7  3/10  per  cent.  Though  the  average  nominal  rate  was 
6  per  cent  the  net  yields  on  these  bonds  were  much  higher,  as 
a  premium  existed  on  gold. 

The  bond  issues  after  1862  followed  one  upon  another  in 
such  large  numbers  and  variety  that  to  follow  them  in  detail 
would  make  too  long  a  treatise  for  this  chapter.  So  complicated 
was  the  debt  of  this  period  that  only  the  expert  can  under- 
stand it.  At  the  close  of  the  War  the  net  debt  was  $2,758,000,000. 
A  large  part  of  this  was  in  short  term  paper  which  was  over- 
due. Less  than  one-half  was  funded;  $26,344,000  was  in  frac- 
tional currency;  and  $433,160,000  in  United  States  legal  tender 
notes.  The  largest  part  of  the  funded  debt  was  in  "five- 
twentys. "  ' '  Only  one-ninth  of  the  debt  ran  in  any  contingency 
longer  than  two  years.  Eight-ninths  of  it  consisted  of  transient 
forms  issued  under  laws  made  up  to  a  great  extent  of  incom- 
prehensible verbiage  giving  unlimited  direction  of  the  mass  over 
to  one  man  and  expressing  in  the  aggregate  nearly  one  hundred 
contingencies  of  duration,  option,  conversion,  extension,  renewal, 
etc.1  .  .  .  The  interest  bearing  debt  consisted  of  loans  bearing 
five  different  rates  of  interest  and  maturing  at  nineteen  differ- 
ent periods."*  Congress  had  yielded  to  the  seemingly  easiest 
method,  a  common  war  policy  in  the  past,  namely  the  issuance 
of  short  time  notes  and  cheap  currency  and  had  avoided  the 
most  difficult  one  that  would  retain  the  credit  of  the  nation, 
the  increase  of  taxes. 

When  George  S.  Boutwell  assumed  charge  of  the  Treasury 
Department  in  1869  a  part  of  the  public  debt  was  soon  sub- 


1Davis  Richard   Dewey,   Financial  History  of   the   United   States, 
p.  333. 

f.,  p.  332. 


UNITED  STATES  BONDS  625 

ject  to  call.  He  at  once  formed  a  plan  to  refund  the  debt  at 
lower  rates,  a  policy  which  was  also  strongly  demanded  on  the 
part  of  the  public.  He  argued  that  European  nations  were  bor- 
rowing at  lower  rates  and  that  these  high  rates  paid  by  the  gov- 
ernment created  an  unjust  competition  with  private  industries 
for  capital.  The  refunding  of  the  debt  was  accomplished  under 
the  Refunding  Act  of  1870,  which  authorized  the  borrowing  of 
$500,000,000  at  5  per  cent  for  ten  years,  $300,000,000  at  4*4 
per  cent  for  fifteen  years,  and  $1,000,000  at  4  per  cent  for  thirty 
years.  These  issues  were  not  to  be  sold  for  less  than  par,  and 
principal  and  interest  were  to  be  paid  in  "coin."  This  Act 
together  with  the  Act  of  1871  and  the  two  Acts  of  1874  and 
1875,  which  supplemented  the  Act  of  1870,  determined  the 
character  of  our  debt  until  the  Spanish-American  War. 

Considerable  difficulty  was  experienced  in  marketing  these 
first  issues  because  the  government  had  taken  no  positive  step 
toward  the  resumption  of  specie  and  the  Inflationists  were 
growing  in  power.  There  was  also  considerable  disagreement 
over  the  use  of  the  word  "coin"  instead  of  "gold"  in  the  Act 
of  1870,  wThich  became  of  greater  importance  in  the  silver  agi- 
tation of  a  subsequent  date.  But  with  the  passage  of  the  Re- 
sumption Act  of  1875,  and  the  settlement  of  the  question  of 
tax  elimination,  the  national  credit  was  well  established.  The  4 
per  cent  bonds  rose  to  a  premium  of  30  per  cent  and  the  ad- 
vantage to  many  national  banks  who  were  original  holders  was 
such  that  they  withdrew  their  circulation  privileges  under  the 
National  Banking  Act  in  order  to  market  these  bonds.  The 
government  within  thirty  years  was  thus  able,  because  of  its 
credit,  to  borrow  upon  a  2%  per  cent  basis.  In  twenty-seven 
years  the  debt  was  reduced  from  $2,756,431,571  (September  1, 
1865)  with  a  rate  of  6.34  per  cent  to  $585,000,000  (June,  1892) 
with  a  rate  of  3.9  per  cent,  while  the  annual  charge  was  reduced 
almost  $130,000,000.  From  a  purely  financial  viewpoint,  as 
Bastable  states,  "the  Federal  government  became  unimportant 
except  in  connection  with  the  management  of  the  Treasury  and 
banking  system." 

"With  the  augmenting  of  the  silver  supply  in  spite  of  the 
steadily  declining  price  of  silver  and  with  the  depletion  of  the 


626  INVESTMENT  ANALYSIS 

government's  gold  supply,  the  government  in  1894  was  forced 
to  issue  bonds  to  replenish  its  gold  supply.  Because  of  the  un- 
willingness of  Congress  to  pass  any  legislation  to  provide 
against  the  further  depletion  of  the  government's  gold  reserve, 
President  Cleveland  was  compelled  to  resort  to  legislation  en- 
acted eighteen  years  before  which  gave  the  Secretary  of  the 
Treasury  the  power,  ' '  to  purchase  gold  by  the  sale  of  any  bonds 
now  authorized  by  law."  This  meant  any  bonds  authorized  by 
the  Act  of  1870.  By  the  end  of  1896,  which  marked  the  defeat 
of  the  silver  party,  the  public  debt,  through  the  various  issues 
made  as  a  result  of  Congress  tampering  with  the  money  system, 
was  increased  to  $250,000,000.* 

The  next  important  Federal  loan  was  the  financing  of  the 
Spanish- American  War.  Congress  authorized  the  issue  of  not 
more  than  $400,000,000  3  per  cent  ten  to  twenty  year  bonds 
and  not  more  than  $100,000,000  treasury  certificates,  together 
with  an  increase  to  the  existing  revenues  and  taxes  which  would 
yield  $100,000,000  per  annum.  Of  this  authorization  of  bonds, 
$198,792,660  were  issued.  The  total  subscriptions  amounted  to 
$1,400,000,000  or  seven  times  the  offering,  and  they  rose  to  a 
premium  of  $111.50  in  May,  1901.  This  premium  quotation, 
however,  was  primarily  due  to  the  fact  that  this  issue  of  bonds 
was  made  legally  acceptable  for  securing  the  issuance  of  na- 
tional bank  notes,  thereby  making  the  bonds  particularly 
attractive  and  profitable  for  national  bank  use.  This  was  the 
last  issue  of  United  States  bonds  which  carried  the  privilege  of 
utilizing  the  bonds  for  circulation.  Another  reason  for  this 
favorable  subscription  was  that  the  bonds  were  offered  at 
popular  subscription  with  bond  denominations  as  low  as  $20, 
and  every  bona  fide  offer  under  $500  was  accepted.  The  bonds 
advanced  in  a  very  few  days,  but  they  soon  passed  into  the 
possession  of  a  few  large  corporations.  The  government, 
through  the  loss  of  these  premiums  and  the  additional  costs  of 
flotation,  sacrificed  more  than  $5,000,000  by  this  popular  loan. 
The  Secretary  of  the  Treasury  later  admitted  that  the  guaran- 
tee of  a  syndicate  to  take  over  the  issue  if  popular  subscription 


'For  a  more  complete  statement  of  this  episode  see  chap.  xix. 


UNITED  STATES  BONDS  627 

failed,  was  the  real  force  that  stimulated  popular  subscription. 
As  David  Kinley  points  out,  a  loan  floated  under  this  specula- 
tive stimulus  can  hardly  be  called  a  popular  loan;  further,  the 
method  of  management  was  expensive  as  the  premium  was  lost 
to  the  government,  and  this  method  of  placing  the  loan  added 
to  the  expense  of  management.1 

In  what  was  popularly  known  as  the  Financial  Bill  of  1900, 
provision  was  made  to  refund  into  2  per  cent  thirty  year  bonds, 
the  outstanding  four  per  cents  maturing  in  1907,  the  five  per 
cents  maturing  in  1904,  and  also  permitted  the  three  per 
cents  to  be  converted  at  their  optional  redemption  date  in  1908. 
Approximately  $900,000,000  bonds  were  convertible  under  this 
law.  The  Act  states  concerning  the  exchange:  "Provided,  that 
such  outstanding  bonds  may  be  received  in  exchange  at  a  valu- 
ation not  greater  than  their  present  worth,  to  yield  an  income 
of  two  and  one  quarter  per  centum  per  annum  and  in  consid- 
eration of  the  reduction  of  interest  affected  the  Secretary  of  the 
Treasury  is  authorized  to  pay  to  the  holders  of  the  outstanding 
bonds  surrendered  for  exchange,  out  of  any  money  not  other- 
wise appropriated  a  sum  not  greater  than  the  difference  between 
their  present  worth  as  aforesaid  and  their  par  value,"  etc. 
The  chief  advantage  was  experienced  by  the  banks,  whose  tax 
was  reduced  one-half  on  their  circulation  privilege,  by  the  con- 
version of  their  short  time  to  long  term  bonds.  This  resulted 
in  greater  profits  being  derived  from  the  circulation  of  bank 
notes. 

The  Federal  Reserve  Act  of  1913  authorized  the  purchase 
of  two  per  cent  bonds  securing  circulation  not  to  exceed  $25,000, 
000  par  value  of  bonds  per  year  from  national  banks  by  Fed- 
eral Reserve  banks  at  par,  whenever  the  Federal  Reserve 
Board  approves.  If  the  national  banks,  however,  desire  to  con- 
tinue the  " circulation"  privilege,  they  may  do  so.  If  no  circu- 
lation notes  are  issued  against  the  bonds  purchased  from  the 
national  banks  by  the  Federal  Reserve  banks,  they  may  ex- 
change 50  per  cent  of  the  amount  of  these  bonds  purchased,  for 


"David  Kinley.  National  Monetary  Commission ;  The  Independent 
Treasury  of  the  United  States  and  Its  Relation  to  the  Banks  of  the 
Country,  61st  Congress,  2  Sess.  Sec.  Doc.  No.  587. 


628  INVESTMENT  ANALYSIS 

thirty  year  3  per  cent  bonds,  and  50  per  cent  of  their  amount 
for  one-year  3  per  cent  gold  notes.1 

The  Act  of  June  28,  1902,  provided  for  an  issue  of  bonds 
not  exceeding  $130,000,000  for  Panama  Canal  expenditures,  of 
which  $84,631,990  were  issued.  They  are  in  denominations  of 
$20  or  some  multiple  of  that  sum.  They  are  redeemable  in  gold 
coin  after  ten  years  from  issue,  are  payable  in  thirty  years, 
and  bear  two  per  cent  interest  payable  quarterly.  The  prices 
realized  for  the  issues  made  under  this  authorization  were:  for 
the  first  issue,  August  1,  1906,  104.036-)- ;  for  the  second  issue, 
November  1,  1907,  102.99;  for  the  third  issue,  November  1, 
1908,  102.436-f . 

The  Act  of  August  5,  1909,  modified  this  latter  Act  and  pro- 
vided for  an  issue  of  $290,569,000  bonds  at  not  to  exceed  3  per 
cent.  This  was  further  supplemented  by  the  acts  of  February 
2,  1910,  and  March  2,  1911.  The  average  price  yielded  by  this 
issue  was  at  the  rate  of  102.5825.  These  three  per  cents,  how- 
ever, cannot  be  used  as  security  for  national  bank  notes. 

The  postal  savings  bonds  were  authorized  by  the  Act  of 
June  25,  1910.  These  bonds  are  redeemable  after  one  year, 
are  payable  in  twenty  years,  and  bear  interest  at  2^  per  cent 
per  annum,  payable  semi-annually.  They  are  issued  in  denom- 
inations of  $20,  $100,  and  $500  and  both  principle  and  interest 
are  payable  in  gold  coin.  These  bonds  may  be  used  by  the 
United  States  Treasurer:  first,  to  redeem  United  States  bonds; 
second,  to  replenish  cash  in  the  Treasury;  third,  to  provide 
long  time  investments  for  depositors  in  the  postal  savings 
banks.  But  they  cannot  be  used  as  security  for  national  bank 
notes  or  Federal  Keserve  bank  notes. 

The  trustees  of  the  postal  savings  service  are  ready  to 
purchase  these  bonds  at  any  time  for  the  postal  savings  fund. 
At  this  writing,  practically  two  millions  have  been  purchased 
under  this  authority.  These  bonds  have  consequently  been 
subject  to  slight  fluctuations. 

With  the  issuances  of  the  European  "War  the  indebtedness  of 
the  United  States  increased  from  approximately  $1,000,000,000 


aSee  Sec.  18  of  Act  for  further  qualifications   to   these  purchase 
privileges. 


UNITED  STATES  BONDS  629 

in  1914  to  a  gross  amount  in  bonds,  treasury  notes  and  war 
savings  stamps  of  $26,596,701,648  (August  31,  1919),  the  maxi- 
mum amount  reached.  The  bond  issues  were  as  follows  : 

Loans  Issued  Xormal  Rate 

First       Liberty  Loans  May  14,  1917  3y2s 

Second   Liberty  Loans  October  1,  1917  4s 

Third     Liberty  Loans  April  6,  1918  4i/4s 

Fourth  Liberty  Loans  September  28,  1918          4i/4s 

Victory  Liberty  Loans  April  21,  1919 


The  details  of  these  issues  have  been  so  completely  covered 
in  the  chart  given  in  the  Appendix  that  further  reference  to 
their  characteristics  does  not  seem  necessary.1  Neither  would 
it  be  possible  in  the  brief  space  allowed  here  to  give  them  ade- 
quate treatment. 

Security  of  National  Bonds.  —  No  class  of  securities  is 
financially  so  strong  and  at  the  same  time  legally  so  weak  as 
national  bonds.  There  are  no  limitations  or  restrictions  to 
which  the  nation  is  subject  except  those  enacted  by  its  people. 
And  as  sovereign  powers  cannot  be  sued,  no  recourse  is  possible 
should  a  national  government  choose  to  repudiate  its  debts. 
The  only  security  is  the  promise  to  pay  and  this  is  dependent 
on  the  credit  and  good  faith  of  the  sovereign  power.  An  inter- 
pretation of  this  credit  and  good  faith  can  be  determined  only 
by  a  correct  historical  interpretation  of  the  nation's  record. 

A  consideration  of  the  theory  of  national  and  state  indebt- 
edness, however,  is  not  within  the  province  of  private  finance, 
but  belongs  to  the  study  of  public  finance.  Nevertheless,  the 
effect  of  the  causes  and  results  of  the  indebtedness  on  national 
and  state  credit  and  the  influence  in  turn  on  the  value  of  their 
securities  are  of  paramount  importance  in  any  consideration 
of  investment  securities. 

As  already  stated,  the  only  security  of  national  or  Federal, 
and  state  provincial  bonds,  is  "the  promise  to  pay"  of  the 
sovereign  power  supported  by  the  power  to  tax.  The  value  of 
that  promise  cannot  be  determined  by  the  same  intensive  method 
of  examination  required  in  determining  the  value  of  corporate 


'For   details  of   these  loans  see   Appendix   C.     In   this  chart  ten 
separate  divisions  of  these  loans  are  given. 


630  INVESTMENT  ANALYSIS 

securities,  but  must  be  ascertained  by  factors  affecting  that 
promise  which  are  external  to  the  security.  And  a  correct  un- 
derstanding of  this  latter,  to  a  large  measure,  is  dependent  on 
historical  knowledge.  One  cannot  proceed  far  in  determining 
the  investment  status  of  national  and  state  loans  before  knowl- 
edge of  the  historical  facts  has  been  obtained. 

With  rapidly  shifting  events  the  people  of  a  nation  are 
prone  to  forget  the  influence  of  change  on  national  credit  and 
merely  assume  that  the  strength  or  weakness  of  national  or 
state  securities  of  their  decade  is  indicative  of  the  status  of 
national  credit.  But  it  is  only  necessary  to  make  a  very  super- 
ficial examination  of  the  origin,  character  and  growth  of  public 
debts  to  disprove  this  belief.  Neither  would  the  explanation 
of  the  public  debt  of  one  nation  be  applicable  in  determining 
the  security  values  of  another.  As  Professor  H.  C.  Adams 
states:  "With  some  the  habit  of  borrowing  money  seems  to  be 
indigenous,  having  sprung  naturally  from  the  political  and 
social  relations  of  their  complex  civilization ;  but  with  others  the 
growth  of  public  debt  is  largely  the  result  of  imitation  or  of 
foreign  interference."1  A  historical  study,  then — a  study  of 
their  past  and  present  debts — is  the  first  step  necessary  toward 
a  comprehensive  understanding  of  national  and  state  securities. 

Any  analysis  of  the  history  and  present  credit  of  a  nation, 
if  it  is  to  give  the  true  credit  status  and  reveal  the  correct 
security  of  a  nation's  bonds,  must  enable  one  to  determine:  (1) 
the  integrity  and  good  faith  of  the  people;  (2)  the  security  and 
stability  of  the  government;  (3)  the  material  resources  and  the 
ability  of  the  people  to  develop  these  resources;  (4)  the  char- 
acter of  the  national  revenues  and  expenditures  and  the  organi- 
zation of  public  credit;  (5)  the  amount  of  the  state's  obliga- 
tions; (6)  the  dependence  upon,  or  independence  of,  foreign 
markets  for  the  marketing  of  its  securities  as  well  as  the  finan- 
cial habits  and  investments  of  the  people;  and  (7)  the  amount 
and  variety  of  securities. 

The  integrity  and  good  faith  of  a  nation's  people  are  di- 
rectly reflected  in  its  economic  and  financial  records  of  the  past. 


JH.  C.  Adams,  Public  Debt  (1892),  pp.  6-7. 


UNITED  STATES  BONDS  631 

A  nation  which  has  demonstrated  that  it  can  produce  and  save 
is  usually  a  nation  where  citizens  are  industrially  efficient  and 
thrifty.  If,  coupled  with  this  ability,  the  people  have  shown 
the  same  attitude  in  the  discharge  of  national  obligations,  the 
strongest  test  is  had  of  the  character  and  integrity  of  the 
population.  The  reputation  which  the  peoples  of  the  United 
States,  Great  Britain  and  France  have  possessed  in  this  regard 
among  the  nations  of  the  world  in  the  last  half  century  ha? 
been  an  invaluable  recommendation  for  the  extension  of  any 
credit  to  these  countries. 

Where  integrity  and  good  faith  exist,  a  strongly  organized 
and  responsible  government  is  sure  to  exist.  The  stability  of 
the  government  rests  upon  the  contentment  of  the  people  of  a 
nation  with  their  government  rather  than  upon  the  form  of  gov- 
ernment. "More  important,  however,"  states  Mr.  Kimber,  "is 
a  consideration  of  the  character  of  the  government  in  all  its 
relations,  both  with  its  own  people  and  with  foreigners,  for, 
as  a  British  authority  puts  it:  If  there  is  no  moral  conscience 
or  sentiment  in  the  actions  of  a  government  in  the  conduct  of 
its  national  policy  there  can  be  no  security  anywhere ;  and  as  a 
corollary  no  confidence  can  be  extended  to  its  instruments  of 
credit. "  *  A  survey  of  national  indebtedness  of  the  last  twenty 
years  and  especially  the  experience  of  the  European  War  demon- 
strate more  than  ever  the  emphasis  that  must  be  placed 
upon  this  internal  relationship  between  a  government  and  its 
people. 

Such  governments  as  Eussia  and  Mexico,  which — so  far  as 
the  casual  observer  could  judge  from  outward  appearance — for 
a  long  period  seemed  to  possess  all  of  the  requirements  of 
stable  governments,  lacked  the  most  essential  fundamentals 
stipulated  above.  For  a  long  time  a  well  organized  administra- 
tive government  was  considered  sufficient  security  for  the  ex- 
tension of  credit  to  nations  such  as  these.  The  recent  War,  as 
well  as  the  experiences  with  some  of  the  Central  American  gov- 
ernments have  clearly  demonstrated  that  over  long  periods  per- 


*Albert  W.  Kimber,  Foreign  Government  Securities  (1919),  p.  218 
(Quotation  from  J.  Taylor  Peddle,  Economic  Reconstruction  [1919], 
l>.  37). 


632  INVESTMENT  ANALYSIS 

manent  and  stable  governments  cannot  exist,  without  acting  for 
the  best  interests  of  their  own  people. 

Bastable  states  that:  "the  financial  power  of  the  state  rests 
on  the  economic  development  of  the  people  and  will  be  propor- 
tional to  it."1  A  people  might  possess  a  strong  government 
and  willingness  to  pay  their  obligations,  but  if  they  possessed 
no  resources  to  develop  or  means  to  produce,  the  former  char- 
acteristics obviously  would  be  of  little  avail.  A  country  need 
not  possess  all  the  raw  materials  for  production,  but  it  must 
have  some  of  the  basic  materials  essential  to  production. 
England,  which  has  had  large  supplies  of  coal  and  iron,  has 
been  able  to  secure  the  other  essential  products  abroad  for  the 
development  of  its  great  textile  industries.  But  even  should 
England's  home  supply  of  coal  and  iron  become  exhausted,  it 
has,  out  of  its  savings,  acquired  the  good  will  and  control  of  raw 
product  markets  through  financing  the  industries  of  other 
countries.  Japan,  which  lacks  some  of  the  more  fundamental 
raw  materials  in  its  own  islands,  has  assumed  an  aggressive 
policy  in  acquiring  territory  possessing  these  materials  on  the 
adjoining  mainland  of  Asia. 

In  the  last  analysis  a  nation  must  possess  not  only  the 
resources  but  the  ability  to  develop  them.  But  even  great  re- 
sources cannot  be  considered  apart  from  a  people.  It  has  long 
been  known  that  China  possessed  wonderful  natural  resources, 
but  it  is  due  to  foreign  capital  and  initiative  that  it  is  now 
developing  them. 

Modern  authority  has  generally  conceded  that  the  revenues 
of  a  government  should  be  sufficient  to  pay  all  expenditures 
excepting  in  extraordinary  emergencies  or  expenditures  for 
enterprises  which  have  a  productive  income.  Illustrations  of 
the  latter  are  the  railways  of  Germany  and  the  salt  monopolies 
of  Peru.  Where  the  income  from  a  productive  industry  is  suffi- 
cient to  support  the  industry  the  same  policies  used  in  the  con- 
trol of  private  enterprises  can  be  followed.  Extraordinary  ex- 
penditures, such  as  those  for  war,  national  calamities,  or  large 
permanent  improvements,  must  usually  be  met  by  loans  instead 


1C.  F.  Bastable,  Public  Finance  (1892),  p.  542. 


UNITED  STATES  BONDS  633 

of  by  taxation.  The  majority  of  these  national  loans  have  been 
created  for  carrying  on  war  or  for  war  indemnities.  The  loans 
for  these  extraordinary  outlays  are  justified  on  the  basis  that 
the  benefits  will  accrue  to  the  future  as  well  as  the  present, 
and  that  therefore  these  charges  should  be  distributed. 

Granting  the  latter,  the  strength  of  the  national  credit  still 
rests  on  the  nation's  ability  to  tax.  As  Henry  C.  Adams  again 
states:  "If  new  taxes  cannot  be  used  as  the  basis  of  war  finan- 
ciering to  the  exclusion  of  credit  it  is  equally  true  that  credit 
cannot  be  so  used  to  the  exclusion  of  new  taxes.  Both  reason 
and  experience  may  be  brought  to  the  support  of  this  asser- 
tion. .  Credit  cannot  sustain  itself.  It  must  be  based  on  revenue, 
and  as  the  ordinary  expenditures  of  the  nation  are  not  mate- 
rially decreased  on  account  of  war,  the  income  from  taxes  must 
at  least  be  increased  to  cover  the  interest  which  accrues  on  the 
loans  contracted.  To  do  less  than  this  would  be  to  base  credit 
on  credit,  a  procedure  which  would  inevitably  lead  to  financial 
disaster. ' '  * 

Another  test  of  the  credit  of  a  large  civilized  country  like 
the  United  States  is  its  ability  to  readjust  its  revenues  and  ex- 
penditures and  float  bonds  in  its  own  market  for  the  financing 
of  a  war  or  exigency.  M.  Neymarck  stated  a  few  years  ago  that 
the  strength  of  the  French  rentes  rested  on  the  fact  that  all 
French  loans  could  be  floated  in  the  home  market.  It  is  true 
that  a  nation  may  effectively  increase  its  borrowing  power  by 
an  expansion  of  loans  in  the  foreign  market,  but  without  a 
large  home  market  the  cost  of  the  loan  must  be  correspondingly 
increased.  It  is  not  essential  to  go  beyond  the  history  of  the 
national  loans  of  the  last  War  to  secure  ample  verification  for 
M.  Neymarck 's  contention.  England,  financially  the  strongest 
of  the  European  powers,  for  the  first  time  entered  a  foreign 
market  to  place  a  loan  in  the  recent  War.  Even  France,  with 
its  large  per  capita  indebtedness  at  the  beginning  of  the  War, 
floated  the  greater  part  of  its  obligations  within  its  own 
borders. 

While  both  the  rapidity  and  the  large  amount  in  which  these 


"Henry  C.  Adams,  Public  Finance  (1906),  p.  535. 


634  INVESTMENT  ANALYSIS 

loans  had  to  be  issued  would  have  caused  undue  pressure,  the 
stronger  nations  could  have  floated  all  of  their  loans  internally. 
The  real  reason  for  the  floating  of  these  particular  loans  abroad 
was  to  check  the  flow  of  gold  and  create  an  offsetting  balance 
in  trade,  thus  securing  the  needed  goods  without  which  they 
could  not  have  succeeded.  A  relatively  small  amount  of  com- 
modities, it  will  be  remembered,  was  imported  into'  the  United 
States  during  the  war  period  from  the  belligerent  nations.  The 
loans  were  consequently  an  advantage  to  both  the  United  States 
and  the  European  countries  securing  these  loans.  The  forced 
necessity  for  these  countries  to  seek  loans  in  foreign  markets 
during  this  period,  consequently,  must  not  be  looked  upon  in 
the  same  light  as  the  necessity  for  a  country  to  seek  loans  else- 
where because  of  its  inability  to  finance  them.  Some  of  the 
earlier  loans  of  Kussia  and  Turkey  are  good  examples  of  the 
latter  class. 

In  the  extension  of  credit  in  normal  times  for  commercial 
purposes,  the  advance  of  the  loan  is  always  made  by  the  nation 
which  is  able  to  finance  its  own  needs.  The  ability  of  a  people 
to  save  enough  above  its  own  requirements  to  make  loans  to 
other  nations  demonstrates  more  than  anything  else  the  story 
of  a  nation's  financial  habits. 

A  large  public  debt  is  not  necessarily  objectionable,  neither 
need  it  be  a  sign  of  weakness.  If  a  large  debt  has  been  created 
for  productive  purposes,  and  is  self-sustaining,  it  must  be 
viewed  in  the  same  light  as  the  indebtedness  of  any  commercial 
enterprise.  The  amount  of  debt  issued  for  all  other  purposes 
must  be  measured  by  the  ability  of  the  people  to  pay.  The 
increased  funded  debt  in  each  succeeding  war,  since  1800,  has 
been  looked  upon  as  the  ultimate  limit  to  which  the  particular 
nation  or  nations  involved  could  go,  h.ut  each  war  has  revealed 
an  increased  wealth  and  income,  with  the  corresponding  power 
to  carry  a  larger  debt. 

The  duration  of  the  last  European  "War  in  1914  was  thought 
of  in  terms  of  the  ability  of  nations  to  finance  previous  wars. 
The  prognosticators,  as  in  other  wars,  failed  to  reckon  fully 
with  the  growth  of  national  wealth  and  income.  While  a  single 
one  of  the  Liberty  Loans  was  larger  than  the  total  war  debt  of 


UNITED  STATES  BONDS  635 

the  Civil  War  in  the  United  States,  they  were  all  absorbed 
more  easily  than  were  any  of  the  Civil  War  Loans.  ' '  The  com- 
bined direct  cost  of  the  wars  in  the  125  years  preceding  this 
war  was  $21,000,000,000.  One  of  these  raged  through  a  period 
of  twenty-one  years.  Another  lasted  four  years."  When  we 
view  these  loans  in  more  distant  perspective,  we  will  fully 
appreciate  that  the  financial  disturbances  caused  by  the  flota- 
tion of  the  huge  loans  by  the  more  important  countries  were  far 
less  than  that  following  any  of  the  wars  in  the  previous  cen- 
tury. The  continued  strength  of  the  banks  is  a  testimony 
of  the  increased  ability  of  the  countries  to  meet  these  obliga- 
tions. The  debt  of  every  period  must  then  be  measured  in  terms 
of  the  ability  to  pay.  Measured  in  these  terms  the  obligations 
of  our  own  country  are  not  so  enormous. 

Many  have  assumed,  because  of  the  increased  taxes  upon 
capital  holdings,  both  direct  and  indirect,  that  the  burden  of 
indebtedness  has  materially  increased.  This  is  merely  a  shift- 
ing of  the  burden  and  must  not  be  confused  with  the  ability 
to  pay.  It  is  true  that  taxes  have  increased,  but  so  have  the 
services  which  the  state  renders.  But  as  long  as  the  ability  of 
a  nation  to  pay  its  obligations  has  increased,  the  security  of 
its  obligations  has  been  enhanced. 

Wealth  and  Income  of  the  United  States. — The  wealth  of 
the  United  States  has  been  variously  estimated  from  $250,000,- 
000,000  to  $300,000,000,000  and  its  income  from  $40,000,000,000 
to  $50,000,000,000  (1918).  With  the  gross  indebtedness  now 
reduced  to  less  than  $25,000,000,000  (November  1,  1920),  the 


'The  Mechanics  &  Metal  National  Bank,  The  Cost  of  the  War 
(1917),  p.  15.  The  following  table  from  the  same  pamphlet  gives  the 
cost  of  the  world's  most  notable  struggles  (p.  15)  : 

Napoleonic  Wars.  1793-1815 $8,250,000,000 

Crimean  War,  1853-1856    1,700,000.000 

American  Civil  War,  1861-1865   8,000,000.000 

Franco-Prussian,  1870-1871   3.500,000,000 

South  African  War,  1900-1902 1,250,000,000 

Russo-Japanese  War,  1904-1905   2.500,000,000 

Estimate  of  Cost  of  Great  War  by  Carl  C.  Plehn  (Introduction  to 
Public  Finance,  1920,  p.  408),  "The  estimated  cost  to  date,  not  including 
pensions  and  similar  unsettled  items,  is  placed  at  $200.000,000,000, 
taking  the  inflated  and  discounted  currencies  at  the  old  parity  with 
dollars.  It  has  left  the  belligerents  with  nominal  debts  amounting  to 
$240.000.000.000  as  against  pre-war  debts  of  $29,000,000,000." 


636 


INVESTMENT  ANALYSIS 


annual  income  is  approximately  twice  the  total  funded  debt.  A 
comparison  of  the  funded  debt  to  the  income  and  wealth  of  the 
nation  with  that  of  European  countries  indicates  the  relative 
financial  strength  of  the  United  States. 

WEALTH  INCOME  AND  DEBTS  OF  IMPORTANT  NATIONS 

Esti-    Estimated 


Pop- 

mated 

National 

Per 

Per 

ulation 

Wealth 

Income 

Capita 

Capita 

in 

per 

per 

Debt 

Debt 

Country1 

Million 

Capita 

Capita 

1914 

1920 

United  States 

104 

$2,404 

$385 

$9.70 

$249.38 

Great  Britain  and 

Ireland.     47 

1,915 

255 

74.50 

817.04 

Germany    

68 

1,215 

162 

76.45 

589.97 

France    

40 

1,625 

187 

162.50 

768.11 

Russia    , 

175 

343 

40 

26.25 

298.61 

Austria-Hungary 

50 

756 

113 

70.25 

976.53 

Italy    

36 

833 

118 

77.75 

408.78 

Belgium  

7.5 

1,200 

246.67 

,  6.2 

560 

5.5 

30.99 

209.86 

Japan  

72 

186 

23.92 

22.14 

Turkey2  . 

21.2 

31.55 

94.11 

As  already  intimated,  the  United  States  has  always  followed 
the  unusual  policy  among  the  nations  of  seriously  attempting 
to  pay  off  its  funded  debt.  In  comparison  with  the  funded 
debt  of  the  countries  in  Western  Europe  in  1914,  the  debt  of 
the  United  States  seemed  exceedingly  small.  The  per  capita 
debt  at  this  time  was  more  than  eight  times  as  great  in  Eng- 
land, Italy  and  Germany  and  more  than  sixteen  times  as  great 
in  France.  Even  with  the  larger  debt  which  the  Unitel  States 
has  assumed  as  a  result  of  the  war-financing,  the  burden  is 
no  larger  than  the  debt  following  the  Civil  War.  The  per 
capita  debt  at  the  end  of  1865  was  approximately  $80  per  capita 
or  lQi/2  per  cent  of  the  wealth  per  capita.  The  indebtedness  at 
the  beginning  of  1920  was  approximately  $275  per  capita  or 
about  10  per  cent  of  the  wealth  per  capita.  Compared  with  our 


*The  Data  in  this  table  are  compiled  from  the  tables  taken  from  the 
pamphlet  on  "The  Cost  of  the  War"  prepared  and  issued  by  the  Me- 
chanics and  Metals  National  Bank,  New  York  City.  The  figures  for 
1920  are  taken  from  Carl  C.  Plehn. 

2Carl  C.  Plehn,  Introduction  to  Public  Finance  (1920),  p.  352. 


UNITED  STATES  BONDS  637 

facilities,  and  our  ability  to  produce,  the  burden  is  much  less 
than  in  the  Civil  War  period.  The  great  geographical  extent 
of  the  country,  linked  with  the  great  diversity  of  raw  materials 
and  climatic  conditions,  give  added  weight  to  this  argument. 

The  Circulation  Privilege. — National  banks  may,  as  pre- 
viously stated,  exercise  the  privilege  of  issuing  national  bank 
notes  to  the  amount  of  their  respective  paid-in-capital.  The 
twelve  Federal  Reserve  Banks,  when  they  purchase  any  of  the 
bonds  held  by  national  banks,  are  accorded  the  same  privilege 
of  issuing  notes  secured  to  the  amount  of  the  bonds  purchased. 
No  national  bank,  however,  is  required  to  give  up  its  circula- 
tion privileges  and  with  some  of  the  amendments  added  under 
the  national  banking  law  the  retention  of  this  circulation  is  even 
more  desirable.  And  as  new  bonds  will  probably  not  be  issued 
with  circulation  privileges,  the  market  demand  for  these  bonds 
will  be  supported  by  the  national  banks  until  maturity.  As 
long  as  a  national  bank  makes  provisions  in  the  calculation  of  its 
profits  for  the  amortization  of  premium  on  the  bonds  purchased 
there  is  the  advantage  of  a  profit  to  a  national  bank  in 
exercising  the  rights  of  this  circulation  privilege,  at  the  present 
price  of  the  bonds  possessing  circulation  privileges.  This,  of 
course,  adds  to  the  strength  of  this  artificial  market  for  bonds 
with  circulation  privileges. 

The  bonds  which  have  the  circulation  privilege  are  the 
Consol  2's,  Panama  2's,  and  Old  4's.  The  difference  to  the 
banks  in  the  use  of  these  respective  bonds  is  in  the  tax  rate  on 
circulation.  If  the  national  bank  notes  are  secured  by  2's  they 
are  subject,  to  a  tax  of  %  of  1  per  cent  and  when  secured  by 
4's  to  a  1  per  cent  tax.  The  maturity  dates  of  these  bonds, 
however,  are  becoming  an  even  more  important  factor  than  the 
tax.  The  Panama  2's  are  the  only  bonds  due  at  definite  dates, 
which  are  1936  and  1938  respectively.  The  optional  dates  of 
1906  and  1918,  since  which  time  the  government  has  had  the 
privilege  of  reducing  the  bonds,  has  not  been  exercised.  The 
Consol  2's  are  due  on  or  after  April  1,  1930,  at  the  option  of 
the  government;  the  old  4's  after  February  1,  1924.  Should 
the  government  exercise  its  privilege  of  the  redemption  of  these 
bonds  at  their  respective  option  dates,  all  other  outstanding 


638  INVESTMENT  ANALYSIS 

bonds  which  retain  the  circulation  privileges  would  receive  an 
additional  market  stimulus.1 

Rate,  Amount,  Denomination,  and  Taxation. — "While  the  net 
return  on  government  bonds  fluctuated  more  or  less,  the  nomi- 
nal rate  on  bonds  after  the  Civil  "War  continued  steadily  down- 
ward to  1891  when  the  first  2  per  cents  were  issued.  It  was, 
however,  self-evident  after  1900  that  bonds  could  not  have  beer 
maintained  at  that  low  rate  except  for  the  existence  of  an 
artificial  market  which  the  circulation  privilege  created.  With 
the  entrance  of  the  United  States  into  the  European  War  the 
first  issue  was  made  at  8^/2  per  cent,  with  full  tax-exempt  privi- 
leges. The  rate  reached  its  highest  mark  in  the  Fifth  Loan  at 
4%  per  cent.  Some  of  the  differences  in  these  rates  can  be 


illustration  of  Profit: 
Value  of  Circulation  Secured  by  $100,000  IT.  S.  Consol    2's,  at  102 

(Money  at  6%) 
$100,000.    2%   Bonds  deposited  in  Washington  would 

yield    $2,000  per  annum 

100,000.     Circulation,    immediately    returned    to    the 

bank  and  loaned  at  6%  would  yield 6,000    "        " 


TOTAL  GROSS  RETURN  FROM  CIRCULATION. .  .$8,000 
From  Which  Deduct: 

Tax  on  Circulation   (%%)     $500 

Expenses  (covering  shipments  of  renewed  cur- 
rency from  Washington )  about*  65 

Loss  of  6%  interest  on  $5.000,  redemption  fund 
to  be  lodged  in  Washington  against  out- 
standing circulation  300  865 


NET  INCOME  TO  BE  DERIVED  FROM 

CIRCULATION    $7,135     " 

Net  income  without  circulation,  obtained  by  loaning 

at  6%  the  net  cost  of  102  for  bonds 6,120    "        " 

INCREASED  INCOME  OR  PROFIT  DERIVED 
BY  OBTAINING  AND  LOANING  CIRCULA- 
TION INSTEAD  OF  LOANING  AMOUNT 

WHICH  BONDS  WOULD  COST  $1,015     " 

The  above  calculations  are  based  upon  $100.000  circulation.  The 
profit  on  greater  or  lesser  amounts  will  be  proportionate.  Assuming  a 
maturity  of  100  years,  a  sinking  fund  sufficient  to  extinguish  the 
premium  price  paid  for  the  bonds  would  amount  to  only  a  few  cents 
per  annum. 

*Average  expense  which  is  more  than  the  estimate  made  recently  by 
the  Comptroller  of  Currency. 

C.  F.  Childs  and  Company.  Pamphlet,  Concerning  Bank  Note  Cir- 
culation Accounts  and  the  Profit  of  National  Banks. 


UNITED  STATES  BONDS  639 

explained  in  the  exemption  privileges  allowed  in  the  different 
loans.  Unless  new  bond  issues  are  made  bearing  the  circula- 
tion privilege,  there  is  little  probability  that  any  more  2  per 
cent  United  States  bonds  can  be  issued  in  the  near  future,  if 
ever.  Prior  to  the  European  War  issues,  all  the  United  States 
bonds  were  exempt  from  all  taxes.  This  was  also  true  of  the 
3!/2  per  cent  and  3%  per  cent  loans  of  the  Liberty  Loan  issues. 
The  4,  4!/4  and  4%  per  cents  were  accorded  certain  exemption 
privileges,  all  of  which  are  stated  in  Appendix  "C."  The  dif- 
ferences between  the  4  per  cents  convertible  into  the  4^  and 
all  of  the  414 's  are  not  important  enough  to  have  any  appre- 
ciable influence  on  the  market  price  of  the  different  issues  at 
this  rate.  The  difference  in  price,  then,  primarily  depends  upon 
the  different  maturity  dates  together  with  the  difference  in  the 
amount  of  the  various  issues  outstanding.  This  difference  in 
prices  must  ultimately  take  place  though  the  public  generally 
is  not  cognizant  of  this  difference.1 

The  total  funded  debt  of  the  United  States  in  1912  approxi- 
mated $1,000,000,000.  On  June  30,  1919,  the  funded  debt  as  a 
result  of  the  European  War  financing  approximated  $25,000,- 
000,000.  This  meant  an  increase  from  almost  $10  per  capita  to 
approximately  $275  per  capita.  Though  this  increase  in  abso- 
lute amount  is  twenty  times  greater,  it  is  not,  as  already  stated 
any  greater  in  ratio  to  the  income  of  the  country  than  the  debt 
following  the  Civil  War  was  to  the  income  of  that  period.  As 
a  consequence,  the  payment  of  this  debt  should  impose  no 
greater  hardship  than  was  experienced  after  the  Civil  War.  As 
the  United  States  unquestionably  will  continue  its  policy  fol- 
lowing other  wars  of  rapidly  reducing  its  debt,  the  effect  will 
be  of  importance  upon  both  its  credit  and  the  prices  of  its 
securities. 

The  past  policies  of  rigidly  limiting  the  increase  of  funded 
debt  and  the  payment  of  funded  debt  have  been  seriously  ques- 
tioned. The  United  States  for  a  long  time  stood  quite  alone 
among  national  governments  as  a  debt-paying  nation.  It  was 
seriously  questioned  whether  the  payment  of  public  debts  was 
not  a  doubtful  procedure.  Certain  European  statemen  for  a 

*C.  F.  Childs.  United  States  Bonds,  Annals  of  the  American  Academy 
of  Political  and  Social  Science,  vol.  Ixxxviii  (March,  1920),  p.  47. 


640  INVESTMENT  ANALYSIS 

long  time  advocated  that  national  obligations  should  all  be  made 
long-time  loans  and  renewed  from  time  to  time,  or  made  per- 
petual obligations.  This  attitude,  however,  has  changed.  The 
United  States  as  a  young  nation  could  not  have  done  any  one 
thing  that  would  have  enhanced  its  credit  as  much  of  the  pay- 
ment of  its  debt  after  the  War  of  1812,  the  Mexican  War  of 
1848  and  especially  after  the  Civil  War. 

The  denominations  of  United  States  bonds  have  a  very  wide 
variation.  They  are  in  $20,  $50,  $100,  $500,  $1,000,  $5,000, 
$10,000,  $50,000  denominations,  and  can  be  issued  in  higher 
denominations  under  special  authority  from  the  Secretary  of 
the  Treasury.  Coupon  and  registered  bonds  are  issued  in  the 
lower  denominations,  though  coupon  bonds  are  not  usually 
issued  for  more  than  $1,000.  Because  of  the  inactivity  in  bonds 
of  large  amounts  and  the  necessity  of  safeguarding  against  the 
loss  of  the  instruments,  the  larger  denominations  are  always  in 
registered  form.  The  generally  accepted  standard  has  been  the 
$1,000  bonds,  but  with  the  growing  demand  for  government 
securities  it  is  not  impossible  that  smaller  issues  will  become 
the  popular  denomination.  The  low  minimum  rate  of  the 
French  rentes  can  never  be  considered  a  possibility  in  the 
United  States  because  of  the  higher  wage  of  the  lower  class  of 
wage  earners  in  the  United  States  and  the  consequent  higher 
standards.  Though  expediency  or  popular  demand  may  neces- 
sitate lower  denominations,  the  greater  cost  of  small  denomina- 
tions will  always  be  an  argument  against  their  issue.  The  suc- 
cess of  the  Postal  Savings  issues  in  bringing  out  hidden  cash, 
and  a  few  of  the  well  directed  sales  of  municipal  issues  in  small 
denominations,  indicate,  at  least,  a  possible  development. 

There  is  no  standard  form  of  maturity  in  Federal  bond 
issues.  They  vary  from  the  emergency  notes  of  one  year,  that 
may  be  issued  by  the  Secretary  of  the  Treasury  to  the  Panama 
3's  of  1861  with  a  life  of  fifty  years.  The  4's  of  1925  were 
also  authorized  as  fifty  year  bonds.  The  lengths  of  other  ma- 
turities, including  the  war  issues  now  outstanding,  from  the 
date  of  issuance  are  ten,  fifteen,  twenty,  thirty,  and  thirty-five 
years. 


UNITED  STATES  BONDS  641 

Registered  bonds  have  a  decided  advantage  in  case  of  loss, 
as  the  payment  of  the  principal  and  interest  can  be  stopped. 
The  only  redress  for  recovery  of  coupon  bonds  is  by  a  special 
act  of  Congress.  Registered  bonds,  on  the  other  hand,  are  at  a 
disadvantage  because  of  the  expense  and  the  trouble  of  trans- 
fer. With  respect  to  bonds  issued  prior  to  1917,  coupon 
bonds  can  be  converted  into  registered  bonds  of  the  same  obli- 
gation, but  "the  law  does  not  authorize  the  conversion  of  reg- 
istered bonds  into  coupon  bonds."  Consequently,  if  the  owner 
desires  to  hypothecate  government  securities,  coupon  bonds  are 
the  more  desirable.  This  advantage  possessed  by  coupon  bonds 
usually  causes  them  to  be  sold  at  a  slightly  higher  price  in  the 
market  than  registered  bonds. 

The  Markets,  Prices  and  Net  Yield. — The  ability  to  dispose 
of  bond  issues,  even  of  the  minor  civil  divisions,  gives  a  direct 
evidence  of  the  material  wealth  and  prosperity  of  the  issuing 
civil  unit,  and  gives  one  a  clue  to  the  security  of  the  issue.  With 
minor  civil  divisions,  the  issue  may  be  too  large  for  the  absorp- 
tion necessary  for  a  successful  bond  sale,  a  condition  which 
must  be  taken  into  consideration.  The  same  may  be  true  of 
state  loans,  but  not  of  national  loans  except  during  the  periods 
of  extreme  emergency  such  as  the  recent  War. 

Prior  to  the  World  War,  the  investing  public  of  the  United 
States  was  able  to  absorb  any  peace  loan  issued,  but  this  ability 
was  more  especially  demonstrated  in  the  war  issues.  These 
issues  were  not  floated  without  effort,  but  their  absorption 
showed  the  latent  resources  in  wealth.  The  large  turnover  of 
small  holdings  in  the  several  months  following  is  not  an  indi- 
cation of  a  glutted  market,  but  rather  of  the  spendthrift  pro- 
pensities of  the  nation  of  which  there  has  been  and  still  is 
an  abundant  testimony  on  every  hand. 

The  contrast  between  the  ability  of  the  United  States  to  fur- 
nish its  own  markets,  and  the  continual  necessity  for  Russia 
and  Turkey  to  seek  other  markets,  is  a  good  illustration  of  the 
value  of  the  home  market,  as  an  evidence  of  the  security  back 
of  national  bonds.  Not  only  have  these  two  latter  countries 
been  compelled  to  find  a  market  for  their  national  loans,  but 


642  INVESTMENT  ANALYSIS 

industrial  developments  have  largely  been  dependent  upon  for- 
eign capital,  though  Kussia  especially  has  sufficient  resources 
to  make  it  the  dominant  empire  of  the  Old  "World.  As  stated 
in  the  beginning,  this  contrast  in  markets  is  an  evidence  of  the 
available  income  of  the  community  which  also  means  a  security 
of  income-producing  wealth. 

The  market  for  United  States  bonds  from  the  Civil  War  to 
1917  was  largely  an  artificial  one.  The  Federal  banking  law,  as 
previously  stated,  requires  every  national  bank  with  a  capital 
in  excess  of  $150,000  to  purchase  a  minimum  of  $50,000  in 
bonds ;  if  the  capital  is  $150,000  or  less,  to  purchase  one-fourth 
of  its  capital  in  government  bonds.  The  market  value  of  these 
bonds  has  been  especially  stimulated  by  national  banks'  pur- 
chases for  the  purpose  of  issuing  their  own  bank  notes  against 
these  bonds.  If  a  bank  desires  to  issue  national  bank  notes  in 
addition  to  this  amount,  it  can  do  so  by  purchasing  additional 
bonds  to  the  amount  of  the  desired  increase  in  circulation 
wanted,  but  limited  to  the  amount  of  its  paid-in-capital.  . 

With  the  revision  of  the  national  banking  law  in  December, 
1913,  this  market  for  United  States  bonds  will  continue,  as  the 
banks  are  not  required  to  give  up  this  privilege,  though  it  may 
be  transferred  to  the  Federal  Reserve  banks,  if  they  purchase 
these  same  bonds  from  the  national  banks  having  the  circula- 
tion privilege.  Still  another  factor  which  has  stimulated  this 
artificial  market  has  been  the  requirement  to  furnish  bond 
security  for  national  banks  that  were  made  depositories  for 
government  funds.  That  is,  for  every  dollar  deposited  by  the 
United  States  government  in  these  banks,  one  dollar  in  United 
States  bonds  or  other  bonds  designated  by  the  United  States 
Treasurer  must  be  deposited  with  the  United  States  Treasurer. 
On  the  average,  about  60  per  cent  of  these  bonds  accepted 
against  deposits  have  been  United  States  bonds.  It  is  gen- 
erally agreed  now,  that  the  disbursements  of  the  United  States 
funds  among  depository  banks  at  the  time  of  the  sale  of  Panama 
3's  at  a  premium,  made  their  sale  possible. 

Bonds  that  are  devoid  of  technical  support  such  as 
security  of  circulation  or  deposits  as  described  above  are  subject 


UNITED  STATES  BONDS  643 

to  general  competitive  influences.  The  transition  of  this  read- 
justment, however,  may  continue  for  a  period  of  years.  The 
length  of  the  period  will  depend  upon  the  action  of  the  gov- 
ernment which  is  still  doubtful,  and  upon  the  competitive 
demand.  As  the  banks  do  not  have  to  sell  the  bonds  below 
par  and  there  is  no  provision  for  new  issues,  the  amount  of 
these  bonds  will  decrease  in  the  face  of  a  continued  and  prob- 
ably increasing  demand  on  the  part  of  national  banks.  This 
would  seem  to  make  it  doubly  certain  that  no  more  2  per  cent 
bonds  can  be  issued  for  a  good  many  years. 

The  market  experience  of  the  United  States  pre-war  bonds 
through  the  early  months  of  the  European  War  appears  on  the 
surface  to  have  been  rather  remarkable.  From  the  declaration 
of  the  war  on  July  28,  1914,  to  January  1,  1915,  government 
2's  fluctuated  within  a  range  of  only  three  points.  It  was 
claimed  by  those  not  familiar  with  the  market  of  Federal  bonds 
that  these  securities,  like  all  securities,  should  have  been  seri- 
ously affected  by  the  closing  of  the  stock  exchange.  To  the 
observant  this  narrow  fluctuation  of  government  securities 
prices  was  not  difficult  to  understand.  The  artificial  market  for 
bonds  still  existed.  The  depressed  demand  growing  out  of  the 
impression  among  many  bankers,  a  few  weeks  earlier,  that  the 
establishment  of  the  Federal  Reserve  banks  would  bring  about 
some  unknown  result  was  found  to  be  a  misapprehension.  The 
market  had  quickly  reacted  from  this  influence,  when  it  fully 
realized  that  the  banks  did  not  have  to  dispose  of  bonds  with 
circulation  privileges,  and  if  the  banks  did  sell  them,  they  would 
only  be  transferred  from  one  institution  to  another.  The  clos- 
ing of  the  exchange  could  have  no  perceptible  effect  on  the 
prices  of  government  bonds,  as  less  than  one  per  cent  of  the 
transactions  in  these  securities  were  made  at  this  time  on  the 
floor  of  the  exchange.  The  purchases  of  the  Federal  Reserve 
banks,  which  were  probably  the  strongest  single  factor  in  sup- 
porting the  market,  were  during  this  period  large  enough  to 
take  up  the  floating  supply. 

With  an  increase  of  an  indebtedness  from  approximately 
$1,000,000,000  to  a  gross  indebtedness  at  its  highest  point  of 


644  INVESTMENT  ANALYSIS 

$26,596,701,648  on  August  31,  1918,  and  with  approximately 
eighteen  million  holders  of  Liberty  bonds,  a  market  reaction 
was  inevitable.  On  the  one  hand,  increasing  price  levels,  rising 
interest  rates,  and  the  lack  of  the  artificial  market  possessed  by 
the  2  's,  and  on  the  other  hand  the  large  amount  of  loans  carried 
by  banks  for  depositors  who  had  not  paid  for  their  bonds  even 
by  the  mid-summer  of  1920,  made  a  fall  of  prices  a  certainty. 
Banks  consequently  were  over-loaned  in  the  advancement  of 
credit  on  these  bonds  not  paid  for,  and  with  the  bonds  which 
they  themselves  held.  Corporations  which  normally  depended 
on  bank  credit  for  a  considerable  proportion  of  their  current 
needs,  found  their  credit  limited  or  the  interest  rates  too  high 
after  the  Federal  Board  raised  its  rates  early  in  1920.  To  bor- 
row on  the  Liberty  bonds  meant  a  heavy  loss — the  other  re- 
course was  to  sell  in  order  to  secure  the  necessary  funds.  Also 
Europe,  which  has  always  furnished  some  outlet,  was  more  than 
incumbered  with  its  own  indebtedness  and  sought  relief  itself 
in  the  United  States'  markets. 

Purchasers  who  continued  to  carry  their  holdings  on  loans 
with  the  banks  were  also  forced  to  renew  their  loans  at  higher 
interest  rates.  Other  private  investors  who  had  not  paid  for 
their  bonds  threw  them  on  the  market  rather  than  pay  a  higher 
rate  than  they  received.  The  supply  temporarily  became 
greater  than  the  demand,  as  those  who  would  have  taken  full 
advantage  of  this  opportunity  were  limited  by  the  cash  funds 
which  they  could  command.  The  amount  of  this  turnover  is 
reflected  in  the  number  of  the  present  holders  of  these  issues 
as  compared  with  the  number  on  May  1,  1919.  Of  the  original 
eighteen  million  Liberty  bond  holders  less  than  25  per  cent  now 
hold  their  bonds.  As  long  as  commercial  banks  must  continue 
to  carry  these  bonds  in  large  quantities  and  until  they  are 
absorbed,  paid  for  and  placed  in  strong  boxes,  inflation  must 
persist  to  a  more  or  less  degree  and  the  market  price  be 
depressed. 

But  the  more  permanent  influence  of  changing  interest 
rates  and  prices  upon  national  bonds  must  not  be  overlooked. 
The  Liberty  loans  must  rest  on  their  own  competitive  invest- 
ment base.  The  experience  of  the  English  consols  in  their 


UNITED  STATES  BONDS  645 

steady  decline  prior  to  1914  under  the  pressure  of  a  rising  price 
level,  is  a  case  in  point.  "With  increasing  price  levels  comes  the 
demand  for  higher  yields,  and  competition  with  other  securi- 
ties becomes  a  pertinent  consideration.  Foreign  and  civil  loans 
and  seasoned  corporation  securities  which  have  survived  three 
panics  must  now  be  reckoned  with,  despite  the  fact  that  no 
other  security  holds  the  enviable  position  of  the  United  States 
bonds. 

The  policy  which  the  Treasury  Department  may  follow  in 
its  handling  of  the  sinking  fund,  especially  until  the  complete 
adjustment  to  normal  conditions,  will  influence  the  market.  If, 
instead  of  using  up  the  fund  from  month  to  month  as  it  accrues, 
it  be  held  in  reserve  until  needed  in  a  particularly  depressed 
period,  it  might  have  some  effective  influence.  There  seems 
scarcely  any  need  of  dissipating  this  fund  when  the  amounts 
are  so  small  that  they  will  have  no  influence  on  the  market. 
Even  if  they  are  allowed  to  accumulate,  their  amount  will  be 
hardly  sufficient  to  support  the  market,  if  call  must  be  made 
upon  them  at  frequent  intervals.  If  public  buying  adequately 
gives  this  support  there  is  no  need  of  an  artificially  maintained 
market.  With  very  heavy  liquidation  of  Liberty  bonds  in  the 
market,  the  support  which  the  funds  from  the  two  and  more 
per  cent  sinking  fund  can  give,  of  course,  will  be  decidedly 
limited.  The  success  of  some  of  the  European  governments  in 
calling  the  bonds  by  lot  at  par  instead  of  buying  them  in  the 
open  market  for  the  sinking  fund  has  been  suggested  by  one 
prominent  authority  on  government  bonds,  as  a  policy  to  be 
followed  by  the  Treasury  Department.1  There  is  no  question  as 
to  the  soundness  of  this  argument.  Although  it  would  not 
force  these  bonds  to  par  at  this  time,  it  would  enhance  their 
price,  as  the  chance  of  "one  in  eighty"  of  being  called,  will 
cause  greater  hesitation  in  selling  the  bonds. 

Of  the  ten  distinct  Liberty  bond  issues  outstanding,  the  two 
tax-exempt  issues,  the  S^s  and  3%s  (except  for  estate  and 


JC.  F.  Childs  and  Company  (Chicago  and  New  York)  Market  Letter 
on  Government  Bonds  for  May,  1920. 

The  War  Finance  Corporation  no  doubt  did  assist  in  a  measure  in 
checking  the  downward  trend  of  prices  early  in  1920  by  its  purchases 
in  the  open  market. 


646 


INVESTMENT  ANALYSIS 


inheritance  taxes),  have  depreciated  the  least  in  price.1  These 
two  issues,  consequently,  have  been  purchased  by  large  investors, 
insurance  companies,  trustees,  etc.,  having  large  incomes,  and 
cannot  be  compared  with  the  other  war  issues.  When  purchased 
by  the  investors  referred  to,  they  are  put  away  in  strong  boxes. 
The  difference  in  the  price  between  the  various  4*4  issues 
should  be  determined  by  the  difference  in  their  maturities,  but 
the  varying  quantities  offered  or  sold  have  largely  offset  this 
normal  corrective.  When  the  market  has  once  been  readjusted, 
maturity  dates  will  control  the  difference  in  prices.2  Mr.  Childs 
in  commenting  on  these  price  differences,  states :  "  As  a  general 
rule,  the  most  inexperienced  investors  select  by  preference  short, 
rather  than  long-time  maturities.  The  two  different  issues  of 
First  41/4s  afford  another  conspicuous  example  of  a  notable 
price  difference.  Both  of  these  bonds  exist  as  the  result  of 
converting  31/2  per  cent  bonds  into  those  with  a  4*4  per  cent 
rate  under  two  different  Acts  of  Congress.  In  the  case  of  the 
First  Liberty  Loan  Converted  4^8,  issue  of  May  9,  there  are 
nearly  $380,000,000  bonds  outstanding,  whereas  in  the  case  of  the 
issue  of  October  24,  there  are  outstanding  less  than  $3,500,000. 


lowest  and  Highest  Recorded  Price  Levels  of  All  Outstanding  U.  S. 
and  Territorial  Bonds  Since  Their  Issuance  to  Date  (August  1,  1921). 

Lowest 
Price 

Consol    2s  94 

Panama  2s 94^4 

Panama  3s   75 

Conversion  3s   75 

Old  4s   104 

Hawaiian  :  Porto  Rican : 

Philippine  4s   78 

D.  C.  3.65s   94 

Liberty  3%s    86.00 

Liberty  First  4s  83.00 

Liberty  Second  4s 81.40 

Liberty  First  4*4s  84.00 

Liberty  First-Second  4*4s 86.00 

Liberty  Second  4%s   81.00 

Liberty  Third  4^s 85.80 

Liberty  Fourth  4%s   82.00 

Victory  3%s 94.60 

Victory  4%s 94.70 

*C.  F.  Childs,  United  States  Bonds,  The  Annals  of  the  American 
Academy  of  Political  and  Social  Science  (March,  1920),  vol.  Ixxxviii. 
p.  46. 


Highest 

Date 

Price 

Date 

1913 

1091/2 

1907 

1913 

105i/2 

1906 

1920 

104 

1916 

1920 

103 

1916 

1919 

1391/2 

1902 

1920 

109 

1913 

1920 

107 

1913 

May, 

1920 

102.50 

Aug., 

1918 

May, 

1920 

98.40 

Jan., 

1918 

May, 

1920 

100.02 

Oct., 

1917 

May, 

1920 

99.00 

Oct., 

1918 

May, 

1920 

102.00 

Oct., 

1919 

May, 

1920 

98.14 

Nov., 

1918 

May, 

1920 

99.10 

May, 

1918 

May, 

1920 

98.10 

Nov., 

1918 

May, 

1920 

100.48 

June, 

1910 

May, 

1920 

100.04 

June, 

1919 

UNITED  STATES  BONDS  647 

Bonds  of  the  former  loan  are  available  in  sufficient  amounts  to 
meet  the  demand  and  still  be  quoted  at  a  substantial  discount, 
but  bonds  of  the  latter  loan  on  the  other  hand  are  scarce  and 
virtually  unobtainable  in  the  open  market,  which  fact  causes 
them  to  be  quoted  at  a  premium  when  an  occasional  block  of 
bonds  becomes  obtainable. ' '  * 


JIbid   (see  the  appendix  also  for  a  chart  compiled  by  this  same 
authority ) . 


CHAPTER  XXXVIII 
FOREIGN  GOVERNMENT  SECURITIES1 

Prior  to  the  European  "War,  foreign  government  securities 
were  unknown  to  the  average  American  security  holder.  Cor- 
porations in  the  United  States,  on  the  other  hand,  secured  large 
loans  abroad  to  help  develop  their  enterprises  in  this  country. 
Consequently  the  international  problem  as  related  to  securities 
was  the  finding  of  a  market  for  United  States  stocks  and  bonds 
and  not  the  finding  of  a  market  for  foreign  securities  in  this 
country.  The  War,  however,  has  reduced  the  former  holdings 
of  the  United  States  securities  in  Europe.  Large  holdings  of 
American  securities  have  been  re-purchased  and  huge  credits 
extended  to  Europe.  At  this  writing,  the  after-war  readjust- 
ment in  financial  affairs  has  not  proceeded  far  enough  to  de- 
termine whether  this  advantage  will  be  retained  by  the  United 
States.  The  present  opportunity  for  the  United  States  to 
establish  itself,  as  a  world  power,  is  one  which  has  never 
before  come  to  any  nation. 

Among  the  European  nations  Great  Britain  has  stood  out 
pre-eminently  as  the  great  lending  nation,  though  France,  The 
Netherlands,  Belgium  and  Switzerland  have  also  occupied  an 
important  place.  It  was  England's  large  ownership  of  foreign 
securities,  both  government  and  private  corporation  securities, 
which  gave  it  a  dominant  position  and  enabled  it  to  assist 
the  Allies  in  their  war  financing.  Mr.  C.  K.  Hobson  states  con- 
cerning the  British,  prior  to  this  period:  "This  'pioneer'  char- 
acter of  British  foreign  investment  is  mainly  attributable  to 
the  willingness  of  many  British  investors  to  assume  risk,  to 
the  extensive  trade  relations  of  Great  Britain."*  In  1914,  the 


JMuch  of  the  discussion  in  the  previous  chapter  on  the  general 
principles  is  applicable  to  foreign  government  bonds  and  consequently 
has  not  been  duplicated  in  this  chapter. 

3C.  K.  Hobson,  Export  of  Capital  (1914),  p.  122. 

648 


649 

total  holdings  of  England  were  estimated  to  be  between  three 
and  one-half  and  four  billions.  The  French  have  not  made  as 
wide  a  diversification  of  their  holdings,  confining  the  larger 
part  of  their  advances  to  adjoining  countries,  and  their  North 
African  colonies.  French  investments  have  been  especially 
heavy  in  Russian  and  Turkish  government  issues.  By  1914,  the 
foreign  listings  in  France  reached  nearly  six  hundred  million. 
Prior  to  the  War,  French  holdings  in  the  United  States  were 
given  at  about  one  billion.  Germany  was  the  last  of  the  Euro- 
pean countries  to  become  a  large  holder  of  foreign  securities.  In 
1914  the  total  German  security  holdings  in  the  United  States 
aggregated  about  one  billion  and  a  quarter. 

The  United  States  prior  to  the  War  occupied  only  a  minor 
role  as  a  lender  of  credit  to  foreign  governments.  The  most 
important  loans  extended  by  the  United  States  before  1914  were 
to  Mexico  in  1899,  1904,  and  1913 ;  to  Cuba  in  1904,  1909,  and 
1914,  and  to  Japan  and  San  Domingo  in  1908  and  1913.  The 
war  conditions  changed  this  situation.  It  was  estimated  that 
about  $235,000,000  were  held  in  national  bonds  of  foreign  coun- 
tries by  private  holders  and  corporations  on  September  1,  1914. 
It  probably  would  be  safe  to  estimate  that  $1,500,000,000  of  for- 
eign government  bonds  were  held  on  January  1,  1920,  by  in- 
vestors in  the  United  States  in  addition  to  the  approximate 
$10,000,000,000  advanced  by  the  United  States  government  to 
Europe.  But  to  maintain  this  position  greater  co-operation  and 
larger  and  more  effective  organizations  are  needed.  Bankers  are 
quite  aware  of  this  necessity  as  well  as  of  the  need  of  the  govern- 
ment's  co-operation  and  goodwill. 

United  States  investors  have  never  had  the  support  OB  co- 
operation that  has  been  given  the  European  foreign  investors 
by  their  governments.  If  we  include  the  international  trade 
relationships  and  the  finances  which  grow  out  of  them,  this  has 
been  especially  true.  The  larger  and  more  important  factor, 
however,  has  been  the  lack  of  capital  within  the  United  States 
for  its  own  needs  and  the  necessity  to  go  abroad  for  large 
amounts  of  capital.  While  these,  statements  are  not  all  speci- 
fically applicable  to  all  government  bonds,  they  do  throw  light 
upon  the  financial  policies  of  a  nation. 


650  INVESTMENT  ANALYSIS 

• 

What  Determines  the  Flow  of  Investment  Between  Coun- 
tries.— All  the  conditions  and  requirements  which  make  a 
sound  investment,  described  in  the  previous  pages  of  this  book, 
are  equally  applicable  to  foreign  government  and  foreign  cor- 
porate securities.  And  though  the  discussion  here  is  primarily 
concerned  with  government  securities,  the  movement  of  funds 
resulting  in  the  buying  and  selling  of  securities  between  two 
different  nations  also  includes  corporation  securities.  What 
then  does  give-  rise  to  the  purchase  of  the  securities  of  one 
country  by  another? 

When  new  countries  are  to  be  developed,  capital  must  be 
secured  from  other  countries — this  is  furnished  in  the  form  of 
finished  goods  and  all  forms  of  equipment.  It  is  not  the  money 
in  itself  which  is  wanted,  but  the  instruments  which  can  be 
utilized  in  the  actual  development  of  the  country's  resources. 
The  immediate  result  then  is  that  the  new  country  has  an  excess 
of  imports  of  those  goods  and  equipment  over  the  products 
which  it  may  immediately  render  in  payment,  either  directly 
to  the  country  furnishing  these  goods  or  to  other  countries. 
And  the  principle  would  be  the  same  if  it  shipped  products  to 
another  country  and  exchanged  this  credit  to  pay  its  own 
balance. 

It  is  not  likely,  however,  that  the  country  will  be  able  to 
produce  a  sufficiently  large  amount  with  which  to  pay  for  all 
the  imports.  To  pay  this  balance,  credit  must  be  secured  from 
the  country  selling  the  goods.  Where  this  balance  may  con- 
tinue for  a  considerable  period  this  advance  of  credit  is  usually 
made  in  the  form  of  a  permanent  loan. 

Exactly  the  same  relationship  would  exist  between  two  coun- 
tries where  one  of  them  becomes  involved  in  war  and  is  forced 
to  turn  its  productive  capacity  to  producing  war  material,  and 
its  man-power  to  carrying  forward  military  activities.  To 
secure  the  means  to  pay  for  food  and  war  supplies,  credit  must 
be  advanced,  for  no  country  ever  carries  a  sufficient  surplus  of 
funds  to  meet  such  extraordinary  expenditures,  and  the  burden 
is  usually  too  great  to  be  met  by  taxation.  The  only  other 
recourse  is  to  secure  large  loans;  and  where  the  war  activities, 
even  of  the  oldest  countries,  become  too  large,  credit  must  be 


FOREIGN  GOVERNMENT  BONDS  651 

secured  from  abroad.  This  credit  will  usually  be  secured  from 
the  country  furnishing  the  supplies.  The  United  States  occu- 
pied this  position  during  the  European  War  in  its  extension  of 
credit  to  Europe.  Not  only  did  the  United  States  buy  back  a 
considerable  volume  of  private  corporation  securities,  but  it 
also  advanced  approximately  ten  billions  in  the  form  of  credit 
to  the  national  allied  governments. 

The  sending  of  goods  is  the  simplest  of  the  forms  of  settle- 
ment, but  balances  may  be  adjusted  by  other  means  than  loans 
or  goods.  For  illustration,  travelers  in  a  foreign  country  may 
spend  large  sums  which  they  have  taken  from  their  home  coun- 
try. The  United  States  travelers  prior  to  the  "War  probably 
never  spent  less  than  $100,000,000  annually  in  Europe.  Immi- 
grants in  America  send  millions  every  year  to  their  kinsfolks  in 
Europe,  again  creating  a  debit  item  in  the  national  balance 
sheet.  Prior  to  the  War,  less  than  10  per  cent  of  the  ocean 
freight  of  the  United  States  was  hauled  in  its  own  bottoms; 
the  charges  on  the  other  more  than  90  per  cent  were  paid  to 
European  countries,  thus  creating  another  debit  balance.  The 
payments  of  such  items  are  called  invisible  balances  in  trade, 
between  two  countries  as  distinguished  from  the  balances 
created  by  the  export  and  import  of  goods,  yet  they  are 
just  as  effective  in  settlements  of  differences.  Payment  for 
any  form  of  services  would  likewise  be  placed  under  the  same 
caption. 

Even  where  gold  is  mined  to  the  extent  that  a  surplus  is 
created  and  exported  from  a  country,  the  export  of  gold  enters 
into  an  adjustment  of  trade  balances  the  same  as  the  export  of 
any  other  commodity.  "A  country  which  produces  specie,  and 
especially  in  modern  times  one  which  produces  gold,  is  in  a 
peculiar  situation.  If  this  be  the  only  item  (or  the  dominant 
item)  over  and  above  ordinary  merchandise  transactions,  the 
country  will  regularly  have  an  excess  of  merchandise  imports, 
just  as  it  would  have  if  travelers'  expenses  or  freight  charges 
had  to  be  remitted.  But  it  will  also  have  a  regular  outflow  of 
specie;  and  therefore  foreign  exchange  will  be  regularly  at  a 
premium.  The  specie  is  in  this  case  an  ordinary  article  of 
export,  like  wheat  or  cotton  or  any  other  commodity.  But  it 


652  INVESTMENT  ANALYSIS 

goes  out  only  when  the  state  of  foreign  exchange  is  such  as  1,0 
warrant  its  shipments." 

The  Character  of  the  Money  System  and  Its  Effect  on  the 
National  Debt. — When  differences  exist  in  the  monetary  stand- 
ards of  two  countries  and  the  debt  is  payable  in  the  standard 
of  value  of  the  country  issuing  the  bonds,  there  is  an  immediate 
influence  upon  the  value  of  the  bonds.  Where  a  country  has  a 
paper  money  or  partial  paper  money  standard,  the  effect  upon 
bond  values  is  even  greater  than  in  a  country  having  a  silver 
standard  and  making  its  bond  issues  payable  in  its  own 
standard. 

As  all  students  of  money  systems  have  shown,  local  prices 
usually  respond  rather  slowly  to  the  changes  in  foreign  ex- 
change rates.  If  the  shift  in  foreign  exchange  rates  from  the 
normal  rates  between  two  countries  is  only  temporary,  reflec- 
tion of  this  change  is  not  likely  in  the  local  markets.  Conse- 
quently, if  the  bonds  issued  in  a  foreign  country  are  payable 
in  the  local  currency  the  holder  is  subject  to  the  risk  of  the 
fluctuation  in  the  exchange  rates.  If  the  bond,  however,  is 
payable  in  the  standard  money  of  the  foreign  country  in  which 
the  bonds  are  sold  the  losses  of  these  risks  must  be  borne  by 
the  countries  issuing  the  bonds.  On  the  other  hand,  the  holder 
in  a  gold  standard  country  of  corporation  stock  of  a  silver  or 
paper  money  standard  country,  would  always  be  compelled  to 
assume  the  risk  of  any  changes  in  the  values  of  the  two  money 
systems.  If,  for  example,  the  value  of  the  paper  money  should 
depreciate,  a  loss  would  be  suffered  and  vice  versa.  Fortunately 
most  government  bonds  sold  in  a  foreign  country  are  now  pay- 
able in  the  money  (or  the  equivalent)  of  the  country  in  which 
they  are  sold. 

Professor  John  Williams  gives  us  a  good  example  of  the 
effect  of  a  paper  money  standard  in  his  first  hand  study  of 
the  international  finances  in  Argentina.2  When  mortgage  bonds 
were  originally  issued  in  Europe,  they  were  quickly  bought 
up  by  British  investors  on  the  strength  of  the  government's 

JF.  W.  Taussig,  Principles  of  Economics  (1915),  vol.  i,  pp.  473-474. 
2John  Henry  Williams,  Argentine  International  Trade  Under  Incon- 
trovertible Paper  Money  (1920),  1800-1900,  chap.  vi. 


FOREIGN  GOVERNMENT  BONDS  653 

guarantee.  The  investors,  however,  had  overlooked  the  very 
important  fact  that  the  interest  on  these  bonds  was  pay- 
able in  the  paper  currency  of  Argentina.  Consequently,  when 
Argentina  faced  its  financial  difficulties,  these  bonds  were 
greatly  depreciated.  Activity  in  sales  back  and  forth  between 
Europe  and  Argentina  depended  quite  directly  upon  the  fluc- 
tuation in  the  exchange  rate. 

An  interesting  episode  in  the  history  of  the  United  States 
illustrates,  how,  even  in  a  well-established  country,  a  threat  to 
seriously  tamper  with  the  money  standard  may  affect  bond 
values.  The  political  compact  of  1890,  here  referred  to,  was 
probably  one  of  the  most  interesting  failures  of  an  attempt  to 
defy  the  principles  of  public  finance  and  monetary  science.  It 
will  be  remembered  that  no  provision  was  made  for  the  coin- 
age of  the  silver  dollar  in  1873,  and  after  1875  the  price  of 
silver  in  gold  fell  rapidly.  As  a  result  of  this  situation,  the 
Bland-Allison  Act  was  passed  in  1878  as  a  compromise  to  the 
Remonetization  party,  and  this  act  continued  in  force  till  1890. 
It  will  also  be  remembered  that  the  national  debt  was  payable 
in  "coin"  and  there  was  a  strong  minority  in  Congress,  from 
the  West  and  South,  who,  because  of  the  large  debtor  class  in 
these  sections,  opposed  the  payment  of  this  debt  in  coin. 

In  the  meantime  the  silver  constituency  in  Congress  had 
been  increased  by  the  addition  of  new  Western  states,  and  this 
increased  the  power  of  the  silver  advocates,  especially  in  the 
Senate.  Three  things  were  necessary  to  satisfy  all  elements  in 
the  party:  namely,  the  passage  of  a  high  protective  tariff,  a 
compromise  to  the  Silver  Republicans,  and  a  reduction  of  the 
surplus  in  the  Treasury.  As  the  Western  Silverites  of  the  Re- 
publican party  opposed  the  High  Protectionists  of  the  East,  and 
vice  versa,  a  compromise  measure  was  necessary.  To  satisfy 
the  East,  very  high  duties  were  placed  on  certain  manufactured 
articles,  so  high,  indeed,  in  some  instances  that  the  revenue  was 
entirely  checked.  To  reduce  the  surplus,  the  tariff  on  sugar 
was  taken  off,  thus  dispensing  with  an  income  of  $50,000,000, 
while  an  increased  outlay  was  made  by  offering  a  bounty  to 
home-grown  sugar.  To  appease  the  Silverites,  the  Bland-Alli- 
son Act  was  repealed  and  the  Sherman  Act,  which  remained  in 


654  INVESTMENT  ANALYSIS 

force  three  years,  was  passed,  providing  for  the  purchase  of 
$4,500,000  of  silver  bullion,  and  Treasury  notes  that  were  made 
legal  tender  were  issued  in  payment. 

This  legislation,  aggravated  by  subsequent  conditions,  re- 
sulted in  such  a  heavy  drain  of  the  gold  supply  that  the 
national  credit  was  greatly  impaired.  There  was  now  added 
every  year  to  the  existing  supply  of  paper  money  of  $345,- 
000,000  in  United  States  notes,  $50,000,000  Treasury  notes 
which  were  also  legal  tender  and  had  no  limitation  or  reserve 
for  their  protection.  At  the  same  time  that  this  expansion  of 
paper  was  making  a  new  demand  on  the  gold  of  the  Treasury, 
the  tariff  was  lowered,  which  made  an  immediate  cut  into  the 
revenues  of  the  government.  With  this  sudden  reduction  of  the 
revenue  and  regular  increase  of  legal  tender  notes,  gold  was 
steadily  drained  from  the  Treasury.  For  as  soon  as  gold  was 
obtained,  either  for  export  or  for  the  payment  of  imports,  the 
notes  would  be  reissued  and  again  returned  by  the  bankers  for 
more  gold.  Thus  the  legal  tender  notes  created  a  vicious  circle. 
Before  1890  not  more  than  $1,000,000  notes  a  year  were  pre- 
sented for  redemption  while  $102,000,000  were  presented  in 
1893.  Further,  this  strain  on  the  country's  finances  was  in- 
creased by  the  demand  that  all  national  debts  be  paid  in  silver 
as  well  as  gold. 

This  caused  a  great  deal  of  consternation  among  holders  of 
Federal  bonds,  especially  among  European  bond  holders,  for  if 
the  demands  of  the  Silverites  had  succeeded,  the  value  of  their 
holdings  would  have  dropped  one-half  on  the  basis  of  the  price 
of  silver  at  the  time.  And  it  would  have  affected  not  only  na- 
tional securities  but  corporate  securities  as  well.  As  a  conse- 
quence, the  New  York  market  was  soon  overstocked  with  securi- 
ties for  sale,  and  both  prices  and  credit  rapidly  fell.  This  in 
turn  caused  an  unfavorable  balance  of  trade  and  a  consequent 
export  of  gold.  Encroachments,  even  beyond  the  point  of 
safety,  were  made  on  the  gold  reserve  to  meet  current  expenses. 
The  banks,  realizing  the  serious  effect  that  this  continuous  drain 
had  on  other  securities,  supplied  the  United  States  Treasury 
with  $31,000,000  in  the  first  quarter  of  1894,  but  it  was  not 
sufficient  to  check  the  demand  on  the  Treasury. 


FOREIGN  GOVERNMENT  BONDS  655 

There  was  only  one  expedient  left  to  conserve  the  gold 
reserve  and  prevent  the  suspension  of  specie  payments,  and  that 
was  to  borrow  gold  by  the  sale  of  bonds.  Congress,  which  was 
now  dominated  by  the  silver  argument  and  political  conspir- 
acies against  the  administration,  refused  to  give  the  Treasurer 
the  authority  to  issue  long  term  bonds.  The  administration 
then  turned  to  the  old  Resumption  Act  of  1875,  under  which 
Act  the  Treasurer  issued  bonds  without  special  authority.  This 
Act  provided  for  bonds  maturing  in  two  years  at  5  per  cent; 
fifteen  years  at  4*4  per  cent  and  thirty  years  at  4  per  cent; 
but  the  Act  as  originally  passed  was  only  intended  to  apply  to 
the  bond  issues  of  1870.  Regardless  of  the  fact  that  the  Act  of 
1870  was  only  meant  to  meet  the  immediate  necessity  for  the 
purchase  of  gold  to  provide  for  specie  payments,  it  prevented 
the  suspension  of  specie  payments  at  this  time. 

In  January,  1894,  $50,000,000  of  5  per  cent  two-year  bonds 
were  sold,  which  yielded  the  government  $58,660,917;  and  a 
second  series  in  November  of  the  same  year  that  yielded 
$58,380,500.  Both  issues  were  sold  through  a  syndicate  and 
caused  a  storm  of  criticism  at  the  time.  This  did  not,  however, 
prevent  the  continued  presentation  of  legal  tender  notes  for  gold, 
though  the  amount  of  the  treasury  notes,  which  had  reached 
$156,000,000  in  1894,  was  now  fixed  by  the  repeal  of  the  Act 
in  1894.  Muhleham  estimated  that  for  the  first  issue  of  bonds 
made  in  1894,  $24,000,000  of  gold  acquired  by  the  sale  of  these 
bonds  was  drained  out  by  the  presentation  of  treasury  notes, 
so  that  the  Treasurer  in  the  end  had  only  about  one-half  the 
amount  of  the  bonds  in  gold  left  in  the  Treasury.  This  in 
turn  was  still  further  lowered  by  the  continued  drain.  In 
February,  1895,  an  attempt  was  made  to  check  this  drain  by 
a  contract  with  the  syndicate  which  Mr.  A.  D.  Noyes  has  called 
"one  of  the  most  remarkable  experiments  in  the  history  of 
finance."  For  the  4  per  cent  thirty  year  bonds  netting 
104.4946,  the  bankers  were  to  furnish  3,500,000  ounces  of  gold, 
of  which  not  less  than  one-half  should  be  secured  abroad.  The 
syndicate  further  agreed  to  accept  3  per  cent  bonds  payable  in 
gold,  reducing  the  interest  25  per  cent,  but  Congress  refused  to 
accept  the  terms  of  the  contract. 


656  INVESTMENT  ANALYSIS 

The  syndicate  at  first  succeeded  on  account  of  favorable 
trade,  but  later  with  a  number  of  adverse  conditions  and  the 
difficulty  of  controlling  foreign  exchange,  which  is  difficult, 
even  under  the  most  favorable  situation,  the  syndicate  failed. 
It  did,  however,  tide  the  United  States  Treasury  over  a  possible 
bankruptcy.  The  Treasury  was  forced  to  make  another  loan, 
but  in  order  to  avoid  the  criticism  that  the  loan  was  under  the 
control  of  banking  interests,  the  loan  was  offered  at  popular 
subscription,  but  $40,000,000  of  the  $100,000,000  was  paid  for 
in  the  withdrawal  of  gold  by  legal  tender  notes.  As  a  result 
the  gold  reserves  continued  to  decrease;  and  in  the  summer  of 
1896,  the  bankers,  realizing  that  another  bond  issue  might  be 
the  determining  factor  with  the  silver  campaign,  combined  with 
the  Treasurer  in  redeeming  the  legal  tender  notes  in  gold.  This 
action,  together  with  the  country's  disapproval  of  the  bimetallic 
standard  in  November,  1896,  caused  gold  which  had  been  hidden 
to  be  brought  out,  and  more  important,  the  withdrawal  of  gold 
from  the  Treasury  ceased  and  sound  national  credit  was 
restored. 

Forms  of  Indebtedness.1 — Modern  national  funded  debt  was 
originally  issued  in  the  form  of  annuities  or,  as  more  commonly 
called,  stocks  (i.e.,  securities  of  perpetual  tenure).  Some  of 
these  issues  still  exist  in  Europe.  It  was  maintained  by  the 
well  known  writers  of  the  period  that  this  added  so  much  capi- 

'NATIONAL  DEBT  OF  SOME  IMPORTANT  COUNTRIES 

(Omitted  000) 

Estimated 

Country                                              Debt  1912*  Debt  1920f 

Great  Britain   $3,479,000  $37.657.000 

France 6,343,000  30,494,000 

Germany    4,869,000  40,007,000 

Russia    4,538,000  54,402,000 

Austria-Hungary    3,812,000  35,980,000 

Italy    2,578,000  15,009,000 

Belgium    1,899,000 

United    States    1,026,000  26,597,000 

Spain  1,804,000 

Holland     465,000 

Bulgaria 171,000  1,158,000 

Portugal  

Japan    1,251,000  1,284,000 

*William  L.  Raymond,  American  and  Foreign  Investment  Bonds 
(1916),  p.  27. 

fCarl  C.  Plehn,  Introduction  to  Public  Finance  (1920),  p.  352. 


FOREIGN  GOVERNMENT  BONDS  657 

tal  and  as  long  as  the  holder  of  the  annuity  remained  a  citizen 
of  the  state,  the  state  was  not  impoverished.1  The  strongest 
argument  against  this  method  is,  that  the  interest  rate  on  a  loan 
cannot  be  adjusted  to  changing  market  conditions.  If  any 
attempt  is  made  to  purchase  it  on  the  market  the  price  is 
forced  to  a  higher  level.  Further,  as  the  price  of  money 
falls,  the  price  of  the  annuity  automatically  increases  in  the 
open  market.2 

The  first  change  from  the  earlier  uses  of  the  perpetual  an- 
nuity was  to  that  of  the  payment  of  the  perpetual  debt  at  the 
government's  will.  This  removed  the  earlier  objections  to  the 
criticism  mentioned  above.  Not  only  can  the  debt  thus  be 
refunded,  but  the  time  at  which  the  debt  can  be  paid  is  deter- 
mined by  the  borrowing  government  itself.  As  these  loans  are 
always  payable  at  par,  the  original  holder  never  suffers  any 
disadvantage,  except  the  surrendering  of  a  security  which 
may  have  an  advantage  over  securities  of  equal  value  in  a  par- 
ticular market.  The  British  consols,  which  can  be  paid  at  the 
option  of  the  government,  are  an  illustration  of  this  type  of 
loan. 

The  new  government  of  the  United  States  naturally  followed 
European  precedent  and  first  adopted  the  simple  form  of  per- 
petual bond  issues,  but  the  closeness  with  which  the  people  came 
in  contact  with  government  affairs  caused  them  to  think  of  the 
payment  of  government  debt  in  the  same  light  as  the  payment 
of  their  own  obligations.  As  a  result,  they  favored  debt  pay- 
ment. And  under  the  Jackson  administration,  for  the  first  time 
in  the  history  of  modern  nations  a  national  debt  was  paid. 
The  change  came  gradually,  of  course,  though  the  persistency 
of  the  movement  was  apparent.  In  the  law  of  February  25, 
1862,  a  new  clause  was  introduced  known  as  the  "limited  op- 
tion," that  is,  the  debt  could  be  redeemed  after  a  certain  date, 
but  not  before,  at  the  option  of  the  government.  The  bond  also 
had  a  definite  maturity  date.  An  example  of  these  issues  was 
the  "five-twenties."  These  bonds  could  be  called  five  years 


^eroy-Beaulieu,  vol.  ii,  p.  199,  Traite  de  la  Science  Francis  (quoted 
from  Henry  C.  Adams,  Public  Debts,  p.  151). 
'Henry  C.  Adams,  Public  Debts  (1892),  p.  152. 


658  INVESTMENT  ANALYSIS 

after  the  date  of  issue  and  were  due  in  twenty  years.1  Small 
use  has  been  made  of  this  form  of  contract  in  Europe  and  it 
has  been  particularly  known  as  the  American  method.  Having 
a  fixed  date  also  gives  the  Treasury  a  more  definite  basis  on 
which  to  adjust  its  finances. 

But  even  after  transition  to  the  terminable  form  of  loan, 
some  of  the  European  countries2  in  times  of  great  economic 
strain  have  returned  to  the  issues  of  perpetual  bonds  as  they 
can  be  issued  with  less  strain  on  the  exchequer.  On  the  option 
features,  however,  the  perpetual  debt  can  be  funded  into  ter- 
minable securities.  This  enables  the  government  officials  to  fol- 
low the  policy  of  paying  its  debts. 

Modern  finance  has  come  to  recognize  that  debt  payment  is 
the  soundest  method  of  public  financing.  This  is  justified,  if 
for  no  other  reason  than  that  such  a  policy  exerts  a  temporiz- 
ing influence  upon  a  nation's  expenditures.  While  the  common 
belief  of  many  is  that  the  British  War  Loans  have  no  termina- 
tion date,  and  thus  are  a  continuation  of  the  old  idea  of  per- 
petual debts,  a  careful  reading  of  the  loan  contract  shows  other- 
wise. Where  definite  maturity  dates  are  not  given,  definite 
provisions  are  provided  for  paying  off  the  obligation.  Other 
illustrations  of  pre-war  issues  are  the  German  Imperial  3  per 
cent  bonds  which  can  be  redeemed  at  the  option  of  the  govern- 
ment, and  the  old  French  3  per  cent  rentes  which  like  all  the  old 
German  Imperial  bonds  have  no  maturity.  When  the  latter 
government  decides  to  cancel  any  part  of  an  issue,  they  are 
selected  by  drawings.  The  decision  of  the  government  in  the 
retiring  of  these  issues  depends  upon  the  current  surplus  in 
the  treasury. 

Other  forms  of  debt  which  must  be  accounted  for  in  the  debt 
obligations  of  national  governments  in  addition  to  the  funded 
debt  are :  current  accounts,  certificates  of  indebtedness,  currency 
notes,  treasury  bills,  scrip  warrants  and  other  forms  of  un- 
covered temporary  obligations.  These  vary  in  nomenclature 
among  the  various  countries,  though  they  are  practically 


'Ibid.,  p.  162. 

2Even  more  recent  German  War  Loans  were  made  with  provision 
that  the  Government  would  announce  redemption  terms  in  1924. 


FOREIGN  GOVERNMENT  BONDS  659 

always  created  to  finance  temporary  indebtedness.1  In  peace 
times  debts  must  frequently  be  met  before  revenues  or  taxes 
are  available,  and  temporary  indebtedness  of  a  few  weeks 
or  months  is  assumed  until  this  income  is  due,  at  which  time 
the  debt  is  paid.  At  times  the  accumulation  of  these  temporary 
forms  of  indebtedness  becomes  so  large  that  a  nation  is  forced 
to  put  the  obligation  into  permanent  form.  This  more  often 
occurs  during  war  periods,  though  ostensibly  the  purpose  of 
the  original  issue  is  not  for  the  purpose  of  anticipating  taxes, 
but  for  the  issuing  of  a  permanent  loan. 

Funds  are  needed  quickly  in  war  operations  and  a  nation 
cannot  wait  for  the  slower  processes  of  effecting  the  sale  of  the 
bonds.  Temporary  certificates  of  indebtedness  are  then  usually 
issued  and  retired  with  the  proceeds  of  the  bond  issues.  Thus 
the  funds  received  from  war  bond  issues  will  often  be  used 
long  before  the  bonds  have  been  sold.  While  all  forms  of  tem- 
porary indebtedness  are  called  Certificates  of  Indebtedness, 
the  name  should  only  be  applied  to  the  instruments  technically 
meeting  their  requirements.2 

The  treasury  bills,  another  common  form  used  during  the 
recent  War,  were  issued  in  large  amounts  without  interest  but 
were  sold  at  a  discount.  Prior  to  the  War  these  were  sold  only 
to  financial  institutions,  but  with  the  attractive  rates  offered 
during  the  recent  European  War,  a  wider  distribution  was 
secured  for  some  of  the  issues.  After  March  1,  1918,  treasury 
bills  were  issued  at  a  fixed  discount  rate. 

Paper  money  issues  may  become  a  serious  incumbrance 
upon  a  nation.  Following  the  European  War,  an  abatement  of 
their  issue  was  urged.  The  year  1919  saw  a  more  positive  in- 
crease, but  a  slowing  up  began  in  most  countries  in  1920,  with 


1In  the  discussion  of  national  loans  no  particular  reference  has  been 
made  to  floating  indebtedness,  as  the  previous  discussion  of  this  type 
of  debt  is  thought  to  be  adequate.  Neither  has  such  so-called  uncovered 
paper  as  the  T'nited  States  Notes  ("greenbacks")  or  the  Currency  Notes 
of  Great  Britain  (Tnder  Act  of  August  <>,  1914).  etc.,  been  referred  to. 
These  latter  forms  of  obligations  and  others  cannot  strictly  be  called 
investments. 

'Jacob  H.  Hollander,  War  Borrowing  (1919).  Professor  Hollander 
gives  a  very  full  and  complete  description  of  the  issuance  of  these 
instrump*  s. 


660  INVESTMENT  ANALYSIS 

probably  the  exception  of  Russia.  In  the  latter  country,  the 
capacity  of  the  printing  presses  seems  to  have  been  the  only 
limitation  of  issue.  Germany's  policy  of  over-issue  of  both 
bonds  and  paper  money,  especially  of  the  latter,  has  placed  a 
burden  upon  it  which  will  greatly  retard  its  return  to  a 
normal  financial  position.  The  experience  of  the  United  States 
with  the  green  back  issues  of  the  Civil  War  period,  and  the 
added  cost  alone,  in  the  sale  of  its  bonds,  for  which  it  accepted 
greenbacks  in  payment  that  fell  as  low  as  thirty-five  cents  on 
the  dollar,  is  a  striking  example  of  the  folly  of  this  method  of 
financing.  The  net  increased  cost  to  the  United  States  gov- 
ernment in  issuing  greenbacks  has  been  estimated  by  Wesley 
Mitchell  at  $528,400,000.1  When  the  increased  costs  of  the 
European  War  as  well  as  its  aftermath2  can  be  calculated,  our 
own  Civil  War  experiences  in  this  country  will  seem  small  in 
comparison.  But  no  comparison  can  ever  be  made  with 
our  Civil  War  experiences,  because  of  government  interference 
and  control  of  prices  in  this  country  after  the  United  States 
entered  the  European  conflict  in  1917. 

In  the  study  of  the  total  obligations,  as  far  as  paper  money 
is  concerned,  a  sharp  distinction  should  be  made  between  the 
so-called  covered  or  partially  covered  and  the  uncovered  paper. 
The  British  currency  notes  issued  during  the  War  are  of  the 
former,  and  the  greenbacks  issued  during  the  Civil  War  the 
latter  type.  The  cover  of  these  notes  should  be,  partially  at 
least,  in  gold  and  in  other  securities.  The  ratio  of  gold  to 
other  securities,  of  course,  determines  the  strength  of  the  notes. 
The  purpose  of  the  British  issue  was  to  relieve  the  strain  on 
the  gold  reserve  and  to  furnish  ample  currency,  though  the 
government  did  later  use  these  notes  for  other  purposes.  They 
did  relieve  the  strain  in  the  first  months  and  gave  reassurance 
to  all  the  financial  markets  of  the  world  as  to  Great  Britain's 
ability  to  handle  its  financial  problems. 

It  has  been  held  that  covered  notes  should  not  be  consid- 


1Wesley  Mitchell,  The  Cost  of  Greenbacks  in  the  Civil  War,  Journal 
of  Political  Economy,  vol.  v,  1897,  pp.  117-156. 

2The  after-war  adjustments  in  Europe,  it  must  le  remembered,  are 
still  in  process  at  this  writing  (January  1,  1921). 


FOREIGN  GOVERNMENT  BONDS  661 

ered  a  part  of  the  obligations  of  a  nation.  This  must  depend 
on  how  large  this  cover  is,  and  how  able  the  nation  is  to  redeem 
these  notes  in  gold;  for,  after  all,  the  ability  to  pay  gold  will 
indicate  a  nation's  ability  to  back  its  bond  issues.  With  un- 
covered paper  money  issues,  a  form  of  compulsory  loan  exists. 
These  issues  are  usually  made  without  interest,  are  payable  at 
demand  or  after  a  fixed  period,  and  usually  pass  as  legal  tender. 
Consequently  their  fluctuation  in  price  quickly  reflects  the 
credit  condition  of  the  country,  as  no  other  basis  of  connection 
exists.  If  the  issues  are  held  within  moderation  and  to  actual 
currency  needs,  they  are  of  value  in  steadying  the  market.  The 
former  greenbacks  are  one  of  the  most  interesting  illustrations. 
The  status  of  these  issues  has  been  changed  since  1900  with  the 
establishment  of  a  gold  fund  of  $150,000,000  which  is  available 
for  the  redemption  of  these  notes. 

Long  time  funded  debt  issued  for  commercial  purposes  by 
governments  under  war  strain,  or  other  great  emergencies, 
where  goods  are  sent  out  from  the  lending  country  cannot  be 
compared  with  loans  through  which  funds  are  taken  out,  with- 
out giving  any  direct  advantage  to  the  producing  facilities  of 
the  country.  The  purpose  of  indebtedness  advanced  through 
private  channels  to  foreign  countries  is  practically  always  for 
the  same  purpose  as  the  former — namely,  the  advancement 
or  selling  of  goods  to  the  borrowing  country.  The  larger  this 
private  credit  can  be  made  with  safety,  the  stronger  will  be 
the  international  financial  position  of  the  country.  At  the  close 
of  the  War  many  bankers  strongly  advocated  that  the  govern- 
ment should  have  assumed  the  burden  of  advancing  credit  to 
Europe  to  purchase  goods  in  this  country.1  This,  the  United 
States  government  strongly  opposed.  Loans  for  food  stuffs  and 
other  commodities,  however,  were  made  to  neutral  countries, 
such  as  the  $30,000,000  loan  dated  August  1,  1919,  at  5%  per 
cent,  to  Switzerland. 

The  very  decided  advantage  accruing  to  the  country  lend- 
ing, is  the  checking  of  the  abnormal  flow  of  gold,  which  turns 
price  levels  topsy-turvy.  Had  the  United  States  government 

'Frank  A.  Vanderlip,  What  Happened  in  Europe  (1919). 


662  INVESTMENT  ANALYSIS 

not  extended  loans  in  the  "War  period  to  European  countries 
the  Allied  cause  would  have  been  much  harder  pressed  in  its 
efforts  to  obtain  war  materials  and  food  and  the  plethora  of 
gold  would  have  eventually  created  a  price  panic  in  the  ulti- 
mate readjustment.  Europe  would  have  been  so  utterly  drained 
of  gold  that  it  is  questionable  whether  Europe  would  not  have 
totally  discarded  the  gold  standard.  This  would  have  left  the 
United  States  in  an  unfortunate  plight.  Hence  the  advantages 
in  the  extension  of  credit  in  the  buying  of  foreign  bonds  reach 
far  beyond  those  of  the  individual  purchases  of  these  bonds. 

Purposes  of  issue  can  be  placed  into  the  two  broad  classi- 
fications of  productive  and  non-productive  purposes.  The  issue 
of  the  Panama  Canal  bonds  by  the  United  States  and  the  French 
loan  in  1907,  to  the  state  of  Minas  Geraes  in  Brazil,  are  illus- 
trations of  productive  issues.  All  war  issues  can  be  placed  in 
the  non-productive  list.  Usually  a  loan  offered  in  peace  times  in 
a  foreign  country  should  not  be  purchased  by  an  investor,  except- 
ing where  the  loan  is  for  productive  purposes,  and  rarely,  if 
ever,  is  a  nation  warranted  in  making  a  loan  except  for  produc- 
tive purposes  during  a  peace  period. 

In  war  time  this  practice  must  often  be  swept  aside,  though 
the  advantage  to  which  a  nation  may  place  these  loans  will  be 
largely  influenced  by  the  past  loans  placed.  England  and 
France,  for  example,  placed  all  of  their  loans  prior  to  the  "War 
internally.  This  clearly  reflected  the  strength  of  these  nations, 
in  absorbing  their  own  loans.  The  payment  of  indemnities  can 
be  placed  in  the  same  category.  The  contrast  between  the  Chi- 
nese indemnity  of  1901  and  the  French  indemnity  payments  of 
1871-1874  is  pertinent  to  the  point.  While  the  French  people 
under  the  burden  of  debt  seemed  stimulated  to  greater  thrift, 
the  Chinese  people  seemed  unable  to  rise  to  this  extraordinary 
need,  and  were  forced  to  go  abroad  to  secure  their  loan. 

The  other  purposes  for  which  national  loans  can  be  issued 
are  for  refunding,  consolidation,  or  conversion  of  existing  issues. 
In  times  of  war  emergency,  when  new  issues  must  constantly 
be  put  out,  both  because  of  the  uncertainty  of  the  war  demands 
and  inability  of  the  market  to  absorb  the  total  amount  of 
issues  at  one  time,  rates  will  be  placed  upon  subsequent  issues, 


FOREIGN  GOVERNMENT  BONDS  663 

in  order  to  secure  a  sale  of  the  issues,  as  with  the  Liberty  bond 
issues.  Consequently,  to  induce  purchasers,  the  first  issues  are 
usually  made  convertible  into  later  issues  at  higher  rates.  As 
stated  elsewhere,  option  dates  have  been  included  in  many  of 
the  bond  issues  of  the  United  States  since  the  Civil  War,  as  in 
some  of  the  European  War  issues.  This  will  provide  for  the 
refunding  of  these  issues,  if  the  government  can  secure  an  ad- 
vantage in  lower  rates  at  a  subsequent  date  or  period. 

The  sale  of  refunding  issues  by  national  governments  must 
be  looked  upon  askance,  excepting  where  bonds  fall  due  during  a 
period  of  war  emergency.  Their  issuance  is  usually  a  reflection, 
as  with  the  refunding  of  all  civil  obligations,  of  the  financial 
weakness  of  the  government.  If  the  government  has  utilized  all 
of  its  available  funds  for  development,  thus  increasing  the  wealth 
and  productive  power  of  the  country,  the  story  is  quite  different 
and  the  refunding  is  legitimate.  But,  if  it  has  spent  large 
amounts  for  war  equipment,  etc.,  which  should  have  been 
obtained  from  taxes  and  revenues,  the  refunding  lacks  justifi- 
cation. 

Consolidations  of  issues  are  frequently  of  value,  in  the  sim- 
plification of  the  bond  issues,  in  securing  better  credit,  and 
especially  in  the  reduction  in  the  interest  rates  which  may  be 
secured.  One  of  the  best-known  examples  of  this  was  the  con- 
solidated issue  made  by  England  in  1888  of  the  British  Consols. 

Repudiation  and  Defalcation. — Since  the  middle  of  the  last 
century  a  number  of  repudiations  of  national  bond  issues  have 
been  made.  Without  an  examination  of  the  final  outcome  of 
these  repudiations,  the  general  public  has  very  naturally 
assumed  that  large  losses  have  resulted.  To  the  contrary,  the 
losses  for  the  last  quarter  of  a  century  have  been  small,  as 
compared  to  the  losses  in  corporation  bonds  in  the  United 
States.1  A  number  of  repudiated  national  securities  which  were 


1PThomas  W.  Lament  states  in  the  Annals  of  the  American  Academy 
of  Political  and  Social  Science  (vol.  Ixxxviii,  'larch,  1920,  p.  123)  that, 
according  to  the  Council  of  the  Corporation  of  Foreign  Bondholders  in 
London  from  the  years  1882  to  1911,  the  average  defalcation  each  year 
per  $100  was  $0.39.  This  compares  well  with  the  defaults  in  the  United 
States  in  Gas  and  Electric  Companies  of  $0.37,  railroads  of  $1.84  and 
industrials  of  $2.07. 


664  INVESTMENT  ANALYSIS 

issued  prior  to  this  period  still  are  considered  as  representative 
of  foreign  bonds  by  the  larger  part  of  the  American  investing 
public.  As  already  stated,  there  has  been  no  necessity  for 
Americans  to  familiarize  themselves  with  either  foreign  national 
government  or  corporate  bonds.  More  surplus  funds  than  the 
United  States  citizens  possessed  were  needed  for  the  development 
of  state  and  private  enterprises.  Consequently,  the  net  yield 
upon  funds  invested  internally  was  larger  than  on  European  in- 
vestments. Capital  was  thus  imported  and  not  exported.  And 
as  with  any  people,  where  a  knowledge  of  complex  foreign  affairs 
is  not  a  necessity,  the  general  American  public  has  been  indif- 
ferent to  foreign  investment.  As  a  consequence,  extraordinarily 
few  facts  concerning  these  securities  are  generally  known,  ex- 
cept by  a  very  few  banking  experts  dealing  in  foreign  bonds. 

It  must  not  be  assumed  from  this  that  repudiations  have  not 
taken  place,  for  they  have.  But  a  settlement  of  a  majority  of 
the  defaulted  obligations  has  ultimately  been  made,  though 
certain  individual  investors  have  suffered  heavy  losses.  Nations 
have  come  to  realize  fully  that  repudiation  results  in  a  serious 
crippling  of  credit.  A  nation  which  has  repudiated  an  obliga- 
tion, regardless  of  the  justification  for  doing  so,  is  either  entirely 
denied  any  further  credit  from  other  nations,  or  must  pay  ex- 
orbitant rates  for  what  funds  are  obtained.  A  nation's  private 
enterprises  suffer  even  more.  The  great  commercial  and  indus- 
trial nations  have  come  to  regard  the  payment  of  national  debt 
as  so  important  that  they  have  used  coercion  in  forcing  payment 
from  small  nations  which  have  actually  repudiated,  or  attempted 
to  repudiate  an  obligation.1 

England 's  foreign  investments  are  probably  the  best  criteria 
of  the  losses  which  have  been  experienced  by  the  investors  in 
foreign  securities.  With  the  policy  of  combination  purchases 
subsequently  referred  to,  the  British  have  cut  their  losses  to 
an  astonishingly  small  figure.*  Not  infrequently  a  temporary 
collapse  has  taken  place,  but  with  an  eventual  recovery  and  full 

lrThe  settlement  of  the  Venezuela  indebtedness  in  1903  with  the 
signing  of  the  protocol  at  Washington  as  a  result  of  the  default  in  1901 
is  a  good  illustration. 

'Interesting  data  are  given  on  these  experiences  throughout  C.  K. 
Hobson'ss  book  on  The  Export  of  Capital  (London,  1914). 


FOREIGN  GOVERNMENT  BONDS  665 

payment  of  obligations.  Where  individual  purchasers  have  held 
securities,  such  as  the  early  Argentine  bonds,  and  have  had  to 
wait  for  their  payment,  the  burden  of  carrying  them  has  been 
costly.  This  difficulty,  however,  is  obviated  by  the  wide  dis- 
tribution which  can  be  effected  by  large  purchases  through 
trustee  organizations.  Temporary  holding  up  of  payments 
under  this  form  of  buying  can  be  carried  without  the  penalizing 
effect  it  would  have  upon  the  individual  investor.  This  is  car- 
rying the  principle  of  diversification  to  a  more  complete  extent. 
It  should  be  adopted  in  greater  part  at  least  for  all  small  in- 
vestors. This  would  not,  of  course,  apply  where  the  purchaser 
of  stock  desires  to  assume  the  risk  of  entrepreneurship  and  its 
possible  gains.  This  is,  however,  a  speculative  and  not  an  in- 
vestment risk. 

The  causes  of  state  defalcation  have  long  been  attributed  by 
the  general  public  solely  to  political  difficulties.  While  political 
causes  of  repudiation  are  the  most  difficult  to  cope  with,  external 
obligations  repudiated  for  political  reasons,  in  the  last  quarter 
of  a  century,  have  been  met  when  the  repudiating  government 
has  regained  its  equilibrium.  A  number  of  the  repudiations 
attributed  to  political  causes  have  been  due  to  economic  reasons, 
though  they  have  been  as  frequently  a  combination  of  both.  But, 
as  was  strongly  maintained  in  an  earlier  chapter,  economic  pres- 
sure tends  to  foment  dissatisfaction  with  existing  governments, 
or  legal  subterfuges  are  created  to  relieve  economic  pressure. 
Russia  is  today  the  only  country  which  for  purely  political 
reasons  has  wilfully  rejected  the  obligations  created  under  the 
monarchy.  Whether  Sovietism  maintains  or  is  replaced,  the 
government  in  power,  if  it  is  to  retain  its  place,  must  eventually 
pay.  The  effect  of  non-payment  by  a  nation  is  too  costly  upon 
its  credit. 

The  attitude  of  some  of  the  governments  to  the  south  of  the 
United  States  seems  to  have  been  one  of  indefinite  postponement 
or  indifference  to  their  obligations.  Reluctance  or  indifference 
of  payment  has  no  doubt  been  aggravated  by  the  ill-fated  ex- 
perience of  the  projects  for  which  some  of  these  obligations  were 
assumed.  Honduras,  whose  external  loan  has  been  defaulted 
since  1873,  is  an  illustration.  Funds  in  this  case  were  raised 


666  INVESTMENT  ANALYSIS 

for  the  purpose  of  building  the  Interoceanic  Railroad.  The 
failure  of  the  nefarious  affair  is  more  attributable  to  the  high- 
handed robbery  of  certain  American  and  English  promoters 
than  to  the  fault  of  the  Honduras  government.1  Ecquador's 
more  recent  default  of  its  4  per  cent  Salt  Bonds  and  of  the  two 
guaranteed  railroad  bonds  of  the  Guayaquil  and  Quito  Railway7 
can  more  justly  be  laid  to  political  causes.  Repeated  requests 
have  been  made  by  the  State  Department  for  a  settlement,  and 
payments  are  now  being  made  on  the  installment  plan.  The 
default  of  issues  of  Guatemala  and  Mexico  were  due  to  a  com- 
bination of  political  influences  and  gross  neglect,  more  to  the 
latter,  however,  than  the  former.  Mexico  has  never  offered  any 
direct  repudiation,  but  since  1914  has  continually  come  for- 
ward with  the  plea  that  it  was  unable  to  meet  the  obligation, 
but  would  resume  payments  as  soon  as  normal  conditions 
return. 

Brazil's  inability  in  1913  and  1914  to  meet  the  interest  on 
its  bonds  was  entirely  due  to  economic  causes.  "With  the  severe 
business  depression  and  the  keen  competition  developed  by  the 
Strait  Settlements  rubber  plantations,  and  other  regions  of  the 
Far  East,  the  price  of  rubber  fell  to  low  levels.  As  Brazil  must 
use  rubber,  one  of  its  chief  exports,  to  meet  its  obligations,  this 
fall  in  the  price  of  rubber  prevented  it  from  paying  the  inter- 
est charges  of  its  bonds  on  August  1,  1914.  Another  difficulty 
at  this  time  affecting  all  markets  was  the  war  development  in 
Europe.  A  plan  was  formulated  by  English  capitalists  for  the 
funding  of  interest  charges  for  three  years  at  5  per  cent.  At 
the  end  of  this  period  payments  were  resumed.  Brazil  has  been 
passing  through  an  over-developed  period  much  the  same  as  the 
railroads  in  the  United  States  did  in  their  early  career. 

Considerable  blame  must  be  placed  upon  the  underwriters 
who  furnished  capital  to  these  countries  without  making  ade- 
quate examinations  of  their  early  experiences  in  financing. 
The  temptation  of  the  enormous  gains  could  not  be  resisted, 


hartley  Withers,  International  Finance  (1916),  chap.  vi.  In  this 
chapter  will  be  found  a  short  sketch  of  this  episode. 

2The  last  available  report  showed  the  amount  of  these  bonds  for  this 
railroad  to  be:  $2,245.950,  6%  Prior  Liens  and  $14,219,900,  5%  First 
Mortgage  Bonds,  together  with  interest 


FOREIGN  GOVERNMENT  BONDS  667 

and  sound  financial  investigations  were  thrown  to  the  four 
winds.  Resources  of  the  country  were  often  inadequate,  and 
the  treasury  of  the  country  overburdened  with  a  debt  which 
it  was  impossible  to  carry.  As  long  as  the  debts  of  the  future 
in  the  strong  Latin-American  nations  to  the  south  do  not  over- 
reach the  ability  of  their  resources  to  pay  for  their  obligations, 
there  is  no  more  likelihood  of  default  than  there  is  with  the 
United  States.  The  former  defaults  of  both  Argentina  and 
Brazil  clearly  resulted  from  an  over-development  and  a  con- 
sequent inability  to  pay.  While  it  is  true  that  revolution  was 
the  cause  which  brought  these  conditions  to  an  immediate  crisis 
in  Argentina,  the  deeper-seated  causes  of  these  insurrections 
were  economic. 

Foreign  Investment  Trusts. — As  far  as  national  control 
enters  into  the  control  of  international  financial  affairs,  this  can 
best  be  secured  by  large  corporations  or  investment  trusts  pur- 
chasing foreign  securities.  The  method  followed  by  such  Eng- 
lish organizations,1  known  as  investment  trusts,  is  to  issue  their 
own  no'tes  or  bonds  against  these  securities.  In  this  way  they 
can  obtain  not  only  larger  holdings,  but  secure  more  favorable 
terms;  and  with  the  large  amounts  of  their  funds  they  can  pro- 
vide the  diversification  essential  in  distributing  risk  and  thus 
secure  greater  safety  for  the  security  holders.  The  possibilities 
in  reduction  of  risk  under  this  type  of  diversification  are  almost 
unlimited.  The  purchases  of  these  trusts  are  not  confined  to 
civil  obligations,  for  some  buy  nothing  but  corporate  securities. 
This  protection  has  been  effectively  accomplished  by  national 
organizations  of  security  holders.  The  Corporation  of  Foreign 
Bondholders  in  England,  organized  in  1868,  is  probably  the  best 
known  of  these  organizations.  Under  the  present  Incorporation 
Act  the  representation  on  its  council  is  composed  of  six  members 
chosen  by  the  Central  Bankers'  Association,  six  by  the  London 
Chamber  of  Commerce,  and  the  other  nine  by  the  Council  as 


1  According  to  the  Stock  Exchange  TnteJHficnce.  1010.  there  are  ap- 
proximately four  hundred  of  these  organizations.  As  Albert  W.  Kimber 
points  out  in  his  book  on  Foreign  Government  Securities  (p.  114)  the 
capitalization  of  the  British  Investment  Trusts  is  not  as  a  rule  large. 
Neither  does  it  necessarily  need  to  be  very  large  to  secure  a  considerable 
diversification  in  investments. 


668  INVESTMENT  ANALYSIS 

a  whole.  This  Council  both  looks  after  the  protection  of  its 
security  holders  and  gathers  data  concerning  the  securities  held. 
In  case  of  default,  difficulties  or  injustices  to  particular  secu- 
rity holders,  this  organization  makes  representations  in  the  behalf 
of  the  security  holders  affected.  It  has  made  adjustments  which 
total  nearly  five  billion  dollars.  Prance  and  Holland  both  have 
similar  forms  of  organizations.  The  Investment  Bankers'  Asso- 
ciation of  America  also  has  a  permanent  committee  known  as 
the  Committee  on  Foreign  Securities,  which  purports  to  perform 
a  similar  service  for  the  American  foreign  security  holders.1 

The  foreign  financial  relationships  of  the  United  States  are 
still  too  new  to  effect  a  very  large  immediate  development  of 
this  method  of  bond  purchasing.  It  does  not  have  the  tangible 
appeal  demanded  by  the  average  American  investor.  National 
development  in  investment  buying  has  not  yet  reached  that 
stage  in  its  evolution.  Machinery,  however,  for  foreign  invest- 
ment has  been  created  by  which  institutions  can  be  provided  to 
carry  on  functions  similar  to  those  of  the  English  Investment 
Trusts.  Needless  to  say,  institutions  of  this  character  must  be 
created  which  can  absorb  large  funded  obligations  if  the  United 
States  is  to  take  over  its  permanent  share  of  foreign  trade.* 

The  so-called  Edge  Act,  though  primarily  created  for  foreign 
trade  purposes,  provides  for  the  corporations  organized  under 
the  act  to  deal  in  foreign  securities.  Any  five  or  more  individ- 
uals with  a  minimum  of  $2,000,000  in  capital  can  organize  for 
the  purpose  of  promoting  trade.  The  organization  must  be 
under  the  control  of  United  States  citizens  and  the  supervision 
of  the  Federal  government.  Included  in  the  provisions  is  the 
power  to  accept  foreign  securities  which  may  be  used  as  security 
for  the  issue  of  the  corporation's  own  debentures.  The  act  fur- 
ther provides  that  these  corporations  can  invest  in  other  cor- 
porations engaged  in  international  trade  to  the  extent  of  10 
per  cent  of  their  own  capital  stock  and  surplus,  and  in  bank- 


investment  Bankers'  Association  of  America,  Bulletin,  July  19,  1919. 

The  American  Foreign  Securities  Corporation  during  the  war  dem- 
onstrated the  ability  of  an  American  organization  to  perform  this  func- 
tion. It  was  organized  with  a  capital  stock  of  $10.000.000.  Against 
securities  pledged  by  the  French  Government  it  sold  in  1916  its  3  year 
5%  Gold  Notes  which  were  paid  at  maturity  to  the  amount  of  $94,500,000. 


FOREIGN  GOVERNMENT  BONDS  669 

ing  corporations  to  15  per  cent  of  their  capital  stock  and 
surplus. 

The  powers  conveyed  under  this  act,  however,  were  not  pri- 
marily supposed  to  serve  the  functions  of  investment  organiza- 
tion, but  to  furnish  the  machinery  for  the  current  financing 
of  foreign  trade.  The  institutions  which  can  be  organized  under 
some  of  the  state  laws  will  more  nearly  meet  the  requirements. 

A  broader  Federal  law  providing  for  this  particular  need 
would,  however,  work  much  more  effectively. 

The  American  Market  for  Foreign  Securities. — American  in- 
ternational bankers  are  generally  agreed  that  if  this  country  is 
to  have  an  uninterrupted  growth  in  the  future,  a  foreign  secu- 
rity market  must  be  developed  in  this  country.  The  position 
held  by  the  United  States  during  the  War  can  be  maintained 
only  by  the  maintenance  of  the  present  credit  and  extension  of 
additional  credit.  Prior  to  the  "War  the  export  of  goods  was 
normally  greater  than  the  import  of  goods.  This  balance  was 
offset  by  our  payment  of  large  interest  charges,  freight  charges 
and  other  services  and  payments  to  Europe.  At  the  present 
writing  the  reverse  situation  which  developed  during  the  War 
still  prevails,  and  credit  is  needed  elsewhere  to  pay  these  bal- 
ances. To  retain  this  position,  it  will  be  necessary  to  continue 
our  investment  in  foreign  securities. 

The  depreciated  exchange  rates,  also  existing  at  this  writ- 
ing, in  many  foreign  countries,  cannot  be  restored  to  normal, 
until  more  complete  credit  facilities  are  made  possible  to  these 
countries.  In  the  long  run,  the  country  possessing  the  advantage 
in  the  exchange  rate  suffers  as  much  as  the  country  with  the 
depreciated  exchange  rate.  If  depreciated  exchange  rates  long 
continue,  American  trade  will  confront  increasing  difficulties, 
as  each  point  in  the  decrease  of  the  exchange  rate  means  a  rela- 
tively larger  decline  in  the  purchasing  power  of  the  country 
with  the  depreciated  rate.  Consequently,  the  more  rapidly 
exchange  rates  can  be  brought  back  toward  normal,  that  much 
sooner  healthy  trade  relationship  can  be  established  with  Europe. 
Even  in  a  less  severe  slump  in  exchange  rates,  the  same  forces 
tend  to  operate,  and  only  when  normal  balances  in  trade  are 
re-established  will  these  rates  be  restored.  While  these  countries 


670  INVESTMENT  ANALYSIS 

even  under  these  severe  handicaps  will  eventually  recover,  the 
process  is  painfully  slow,  and  the  advantage  to  our  own  indus- 
tries, arising  out  of  these  peculiar  conditions,  will  be  lost. 

As  industries  in  our  country  during  the  next  half  century 
will  far  exceed  their  markets,  if  not  handicapped  by  financial 
difficulties,  it  behooves  the  nation  to  take  some  forethought  of 
this  situation.  It  will  be  necessary  to  find  new  and  broader 
markets  to  dispose  of  these  products.  And  broader  markets  will 
tend  also  to  give  greater  stabilization  to  industry.  All  the  lead- 
ing European  nations  are  now  perfecting  far-reaching  plans  to 
re-establish  themselves  in  their  old  and  new  foreign  markets,  so 
that  with  the  return  to  normal  conditions  they  will  be  in  control 
of  these  markets.  Further,  ''trade  always  follows  the  invest- 
ment in  a  foreign  country."  "Without  markets  industry  is 
destitute;  and  without  foreign  investment,  foreign  markets  are 
not  to  be  had.  The  alternative  is  to  lend  our  money  to  other 
nations.  .  .  .  "*  Unless  this  can  be  done,  as  this  same  author 
suggests,  we  will  be  undersold  in  foreign  markets.  As  long  as 
our  own  markets  can  absorb  the  greater  part  of  the  country's 
production  of  goods,  this  latter  statement  need  not  be  given  very 
serious  consideration — but  if  it  cannot,  then  there  is  no  alterna- 
tive for  us. 

The  position  which  the  United  States  occupied  in  the  pre- 
war period  is  best  illustrated  by  the  ratio  of  its  foreign  security 
holdings.  Out  of  approximately  2,200  securities  on  the  New 
York  Stock  Exchange  on  January  1,  1914,  there  were  14  for- 
eign issues,  whereas  the  foreign  securities  listed  on  the  London 
Stock  Exchange  were  approximately  48  per  cent  of  the  total 
listings  and  on  the  Paris  Bourse  40  per  cent.  The  total  listed 
and  unlisted  foreign  loans  in  this  country  are  now  slightly  over 
the  half  hundred  mark.  This  includes  some  of  the  short  dura- 
tion issues,  though  it  does  not  include  the  loans  advanced  by 
the  government.  It  is  evident  that  relative  to  the  holdings  of 
the  leading  European  countries,  foreign  security  holdings  in 
the  United  States  are  still  small. 


1James  Sheldon,  The  Need  for  American  Investment  in  Foreign  Se- 
curities, Annals  of  the  American  Academy,  vol.  Ixxxviii  (March,  1920), 
p.  119. 


FOREIGN  GOVERNMENT  BONDS  671 

The  advantages  of  well-selected  foreign  government  securities 
will  give  unusual  diversification  to  the  holders'  investments.  It 
is  now  common  knowledge  that  one  of  the  reasons  for  Great 
Britain's  ability  to  adjust  itself  so  rapidly  to  the  financial 
demands  of  war  was  the  great  diversification  of  its  invest- 
ments. With  the  great  holdings  in  American  securities,  Great 
Britain  was  able  to  mobilize,  and  sell  back;  consequently  it  not 
only  secured  immediate  credit,  but  instilled  great  confidence  by 
its  ability  to  handle  financial  problems.  While,  as  stated  in 
chapter  two  of  this  book,  large  diversification  in  foreign  hold- 
ings is  more  important  to  small  European  countries  than  to  our 
own  because  of  our  great  geographical  area,  holdings  in  other 
countries  during  a  war,  would  be  a  decided  asset. 

Of  the  ability  of  the  United  States  market  to  absorb  foreign 
securities  no  question  need  now  be  raised.  Neither  can  any 
question  be  raised  as  to  the  necessity  of  future  investment  in 
foreign  holdings  to  protect  our  own  markets.  For,  if  markets 
are  not  maintained,  industry  is  checked — earnings  fall  off  and 
savings  with  which  investments  are  made  possible,  correspond- 
ingly slow  up.  With  the  ability  to  buy  and  the  need  and  desir- 
ability for  the  purchase  of  foreign  securities,  the  market  is  ripe 
for  development.  If  in  1920  we  had  possessed  greater  familiar- 
ity with  some  of  the  foreign  markets,  the  distribution  of  foreign 
securities  would  have  been  even  much  larger.  But  without  doubt 
the  next  quarter  of  a  century  will  see  a  very  substantial  hold- 
ing in  both  foreign  government  and  foreign  corporate  bonds. 

Price  of  Government  Bonds. — The  net  yield  of  government 
bonds  directly  reflects  the  credit  of  the  issuing  country.  Pecu- 
liar conditions,  such  as  the  market  for  the  United  States  2  per 
cent  bonds  or  the  temporary  market  of  the  British  Consols  in  the 
nineties,  may  create  an  artificial  market.  Prices  under  these 
conditions  would  obviously  not  reveal  the  true  credit  of  the 
issuing  nation,  though  a  comparative  study  of  the  prices  them- 
selves will,  over  long  periods,  reflect  the  strength  of  the  national 
credit.  Occasionally  the  market  of  a  national  government  bond 
will  be  absurdly  out  of  line  with  the  nation's  credit,  but  this  is 
the  exception  and  not  the  rule. 

Shifting  price  levels  will  always  have  an  immediate  effect  on 


"672  INVESTMENT  ANALYSIS 

the  price  of  government  bonds.  While  this  effect  may  only  be 
fractional  on  low-yield  government  bonds,  it  is  comparatively  as 
great  as  with  other  high-grade  bonds.  The  long  downward 
trend  of  bonds  of  all  first  power  European  countries  after  1898, 
even  after  an  allowance  is  made  for  the  changes  in  the  nominal 
rates,  was  due,  as  previously  stated,  to  the  world-wide  increase 
in  price  levels.1  Adverse  political  agitations  may  for  a  time 
depress  prices,  but  they  will  not  continue  to  do  so  very  long. 
This  is  illustrated  in  all  the  experiences  of  the  English,  French, 
and  German  bond  prices  during  the  past  century.2 

War  will  always  depress  the  price  of  government  securities 
regardless  of  a  nation's  strength,  though  the  country's  credit 
may  be  in  no  way  impaired.  Military  successes  or  reverses  will 
on  the  other  hand  always  have  an  effective  influence  in  forcing  a 
price  change,  especially  among  the  weaker  nations.  Where  the 
nation  has  been  so  markedly  defeated  as  have  certain  European 
countries  in  the  recent  War,  the  national  credit  is  so  impaired 
as  to  force  the  prices  of  the  securities  of  these  governments  below 
their  actual  value.  But  when  the  only  guarantee  of  a  govern- 
ment is  its  will  to  pay,  values  must  be  viewed  from  other  than 
the  financial  ability  to  pay.  A  comparison,  however,  of  the 
prices  of  the  securities  of  strong  national  governments,  will  show 
less  fluctuation  than  in  any  other  class  of  securities. 

Money  market  changes  of  two  or  more  foreign  countries  will 
immediately  reflect  themselves  in  the  securities  of  these  govern- 
ments. These  changes  in  the  normal  rates  for  money  are  usually 
temporary,  and  result  only  in  short  speculative  swings.  Again 
the  general  discussions  on  markets  and  prices  in  the  previous 
chapters  are  applicable  here. 


'United  States.  National  Monetary  Commission,  Senate  Document, 
Xo.  570,  pp.  278-282. 

2Thomas  W.  Lament,  Foreign  Government  Bonds,  Annals  of  Amer- 
ican Academy  of  Political  and  Social  Science,  vol.  Ixxxviii.  (March, 
1920),  p.  122. 


APPENDIX 

A.  Catalogue  of  Bonds. 

B.  Table  of  the  Present  Outstanding  Liberty  Bonds  of  the 

United     States     Government     Together    With     Their 
Important  Kegulations. 

C.  Income  Analysis  of  the  American  Telephone  and  Telegraph 

Company. 

K.     Selected   Topical   Bibliography. 


APPENDIX  A 

CATALOGUE  DESCRIPTION  OF  THE   MORE 
IMPORTANT  BONDS 

[A  more  complete  discussion  of  the  bonds  followed  by  a  (*) 
will  be  found  in  the  subject  matter  of  the  text.] 

Adjustment  Bonds. — These  bonds,  of  which  very  few  are  outstanding, 
have  been  issued  in  railroad  reorganizations,  for  the  purpose  of  re- 
adjusting the  old  funded  debt;  (i.  e.,  bonded  debt),  usually  for  the 
purpose  of  scaling  it  down. 

Anticipation  Tax  Warrants. —  (See  Revenue  Bonds). 
Assented  Bonds. — When  an  effort  is  made  to  reorganize  a  road,  it  may 
be  necessary  to  submit  a  plan  asking  for  concessions  from  the  bond- 
holders. If  they  assent,  the  bonds  or  notes  are  sent  to  the  designated 
depository,  and  this  condition  is  stamped  on  the  bond.  (These  Bonds 
are  frequently  called  Stamped  Bonds.)  The  bonds  are  then  trans- 
ferred, subject  to  these  new  conditions. 

Assumed  Bonds. — When  a  corporation  purchases  another  corporation 
and  agrees  to  pay  the  principal  and  interest  of  the  latter  corporation's 
bonds,  these  bonds  are  called  Assumed  Bonds.  If  these  bonds  have  f 
specific  lien,  this  lien  maintains,  and  any  loss  of  identity  of  the  old 
company  does  not  affect  the  value  of  the  bonds. 

Blanket  Mortgages. — Mortgages  issued  as  security  on  one  debt  and 
secured  by  a  number  of  separate  properties,  or  a  group  of  properties, 
are  termed  blanket  mortgages.  They  are  closely  akin  to  the  general 
mortgages,  and  the  two  terms  are  not  infrequently  used  interchangeably. 
If,  however,  accurate  technical  distinctions  are  adhered  to,  a  difference 
should  be  made  between  these  two  mortgages. 

General  mortgages  cover  different  properties,  but  are  managed  and 
operated  as  a  unit  under  the  control  of  one  corporation.  Blanket 
mortgages  may  be  placed  as  they  generally  are,  on  several  properties 
that  are  wholly  unrelated. 

Bonus  Bonds. — The  strictly  bonus  bond  is  an  old  form,  which  was 
issued  to  corporation  promoters,  or  sold  by  a  municipality  to  pay  pro- 
moters of  an  enterprise  who  established  an  industry  within  its  borders. 
Bridge  Bonds. — These  bonds  are  issued  both  by  municipalities  and 
private  corporations  for  the  purpose  of  erecting  large  bridge  structures. 

675 


676  INVESTMENT  ANALYSIS 

Where  the  structure  is  very  large,  or  is  to  be  used  by  several  systems, 
railroads  usually  organize  a  separate  company  for  the  purpose  of 
financing  it.  In  some  cases,  as  in  the  organization  of  wharf  or  ter- 
minal companies,  the  company  is  forced  to  avoid  the  "after  acquired 
property  clause"  in  the  mortgage  to  secure  sufficient  funds,  and  this 
fact  necessitates  the  organization  of  the  separate  company. 
Callable  Bonds. — A  bond  which  has  in  the  instrument  a  clause  provid- 
ing for  the  retirement  of  the  bond  before  its  maturity  is  a  Callable 
Bond.  This  clause  may  give  the  privilege  of  calling  the  bond  in  whole 
or  part  or  both.  When  a  call  has  been  made  for  an  issue  of  bonds,  the 
interest  ceases  at  the  designated  date  of  retirement.  If  the  corporation 
has  complied  with  all  the  legal  requirements  of  notification,  the  se- 
curity holder  can  claim  no  further  interest  if  he  neglects  to  surrender 
his  bond  on  its  due  date. 

Car  Trust  Bonds  (*). — When  the  Equipment  Association  (organized 
for  the  purpose  of  financing  the  railroad's  equipment  needs)  leases  the 
equipment  to  the  railroad  and  the  lease  itself  is  used  as  a  direct  security 
for  the  obligation,  the  bonds  are  termed  Car  Trust  Bonds,  as  dis- 
tinguished from  the  Car  Trust  Certificates  which  represent  certifi- 
cates of  participation  in  the  Association.  In  the  issuance  of  Car  Trust 
Bonds,  the  lease  of  the  equipment  securing  the  bonds  is  assigned  to 
a  trustee  and  the  bonds  as  already  stated  are  issued  against  this 
security. 

Car  Trust  Certificates  or  Notes  (*). — These  certificates  are  issued  by 
equipment  associations,  corporations  or  individuals  which  lease  equip- 
ment to  railroads  with  the  contract  in  the  lease  providing  for  the  pay- 
ment of  the  obligation  with  the  payment  of  the  lease.  As  the  lease  is 
paid  annually,  or  semi-annually,  the  payment  to  the  purchasers  is  usually 
made  in  serial  form.  Few  of  these  obligations  are  retired  by  means  of 
the  use  of  a  sinking  fund  provision.  Formerly,  individual  warrants 
were  issued  covering  the  payments  of  the  separate  rentals ;  this  is  no 
longer  considered  necessary,  as  they  are  fully  covered  in  the  lease. 
(For  a  more  complete  discussion  see  Chapter  on  Railroad  Equipments.) 
Certificates  of  Beneficial  Interest. — These  securities,  strictly  speaking, 
are  merely  a  modification  or  form  of  the  Collateral  Trust  Bonds.  Cer- 
tificates of  Beneficial  Interest  have  been  used  chiefly  in  acquiring 
control  of  corporations  with  a  minimum  expenditure  of  money.  The 
stock  of  the  corporation  to  be  controlled  is  deposited  with  a  voting 
trust  and  the  Certificates  of  Beneficial  Interest  are  issued  against  the 
deposited  stock,  the  security  of  the  certificates  depending  upon  the 
assets  and  earnings  of  the  corporation. 

Certificate  of  Indebtedness. — A  certificate  of  indebtedness  represents  a 
temporary  debt  of  a  municipal  corporation,  which  is  drawn  up  in  more 
formal  form  than  the  promissory  note.  Where  the  loan  is  a  large 
one,  notes  of  smaller  denominations  are  often  issued  against  this  indebt- 


APPENDIX  677 

edness.  If  defaults  in  payments  take  place  the  holder  may  ask  for 
receivership.  (See  Town  Warrants.) 

City  and  Town  Bonds  (*). —  (See  Text  for  discussion  of  these  issues.) 
Collateral  and  Participating  Bonds. —  (See  Participating  Bonds  and 
Collateral  Bonds.) 

Collateral  Income  Bonds. — The  principal  of  these  bonds  is  secured  by 
collateral  paper  (see  Collateral  Trust  Bonds)  and  the  interest  payments 
are  dependent  upon  earnings.  (See  Income  Bonds.) 
Collateral  Mortgage  Bonds. — These  Bonds  are  secured  by  collateral 
paper  which,  in  turn,  is  directly  secured  by  a  mortgage  lien.  (See  Col- 
lateral Trust  Bonds.) 

Collateral  Notes. — These  securities  have  the  same  characteristics  as  col- 
lateral trust  bonds  except  in  so  far  as  notes  differ  from  bonds.  (See 
Collateral  Trust  Bonds.) 

Collateral  Trust  Bonds. — The  collateral  trust  bonds,  are  those  bonds 
which  are  secured  by  other  collateral  securities  (bonds  or  stocks). 
These  collateral  securities  may  be  the  securities  of  the  issuing  com- 
pany, its  subsidiaries,  or  the  securities  of  other  companies.  Hypothe- 
cated securities  of  companies,  foreign  to  the  issuing  corporation,  other 
things  being  equal,  are  the  most  desirable  form  of  collateral  security. 
Where  the  issuing  company  has  had  the  privilege  of  substituting  other 
collateral  of  equal  value  and  the  deed  of  trust  has  been  badly  drawn 
up,  the  holder  of  the  security  has  little  protection.  This  fault  has  been 
a  not  uncommon  weakness,  of  an  otherwise  desirable  collateral  trust 
bond.  When  the  terms  of  the  trust  deed  have  been  approved,  unless  an 
examination  of  the  issuing  corporation  and  the  corporation  whose  se- 
curities have  been  hypothecated  can  be  made,  it  is  of  little  use  to 
examine  the  security  further  for  a  conservative  investment.1 

Collateral  securities  have  occupied  a  prominent  place  in  railroad 
financing,  since  the  original  issue  of  the  Union  Pacific  in  1S79.  For 
a  number  of  years  the  use  of  collaterals  was  the  favorite  method  of 
financing.  The  separate  state  jurisdictions  forced  the  organization  of 
separate  companies  within  each  state.  These  companies  could  not  often 
market  their  own  securities,  and  the  parent  company  was  compelled  to 
take  the  securities  of  these  subsidiaries  and  use  them  as  security  for  its 
own  issues. 

Since  1897,  collateral  trust  bonds  have  been  used  in  the  financing 
of  the  holding  company.*  This  form  has  a  decided  advantage  to  the 
corporation  in  the  readiness,  as  compared  to  other  bonds,  with  which  the 
bonds  can  be  withdrawn  and  the  bonds  or  stocks  securing  the  debt  can  be 


"Thomas  Warner  Mitchell,  Quarterly  Journal  of  Economics,  vol.  xx, 
1906,  pp.  445-467.  (This  is  the  best  single  article  on  Railroad  Collateral 
Trust  Bonds.) 

2W.  Z.  Ripley,  Railroads,  Finance  and  Organization,  pp.  143-156. 


678  INVESTMENT  ANALYSIS 

sold.  The  corporation  also  has  the  advantage,  if  provided  in  the  trust 
deed,  of  substituting  the  underlying  collateral.  This  privilege  has  been 
particularly  abused  in  real  estate  bonds.  There  is  also  a  temptation  for 
the  corporation  to  use  its  collateral  holdings  for  speculative  purposes, 
and  a  good  many  holders  of  these  securities  have  suffered  heavy  losses 
through  the  unfortunate  attempts  of  corporations  to  enrich  themselves. 
To  safeguard  against  this,  no  exchange  of  collateral  should  be  allowed 
except  by  very  specific  regulation  given  in  the  trust  deed. 

Distinction  is  seldom  made  between  a  collateral  mortgage  secured 
by  stocks  and  one  secured  by  bonds.  Even  conservative  investors,  who 
would  never  buy  stocks,  purchase  collateral  issues  secured  by  the  weak- 
est stock.  As  a  speculative  purchase,  these  issues  are  very  desirable. 
Collateral  bonds  secured  by  stocks  will  not  only  fluctuate  more  widely  in 
sjmpathy  with  the  stocks  securing  them,  but  they  are  very  much  more 
sensitive  to  market  changes.  If  the  collateral  bonds  are  used  as  a 
means  to  pay  off  the  floating  debt,  or  are  secured  by  such  of  the  com- 
pany's own  securities  as  could  not  be  marketed  and  were  later  used  as 
collateral,  they  are  fraught  with  possible  weaknesses. 

Consolidated  Bonds. —  (See  Consolidated  Mortgage  Bonds.) 

Consolidated  and  Refunding  Mortgage  Bonds. —  (See  Consolidated  Bonds, 
also  Refunding  Mortgage  Bonds.) 

Consolidated  First  Mortgages. —  (See  Consolidated  Mortgage  Bonds.) 
These  bonds  are  based  on  a  first  mortgage  on  all  properties  which  have 
been  consolidated.  Other  mortgages  may  exist  on  the  separate  prop- 
erties, but  this  is  the  first  issue  on  the  combined  properties. 

Consolidated  Mortgage  Bonds. — The  title  of  many  bonds  having  this 
prefix  does  not  always  convey  what  the  name  might  seem  to  imply. 
Consolidated  mortgage  bonds  are  used  in  two  quite  distinct  meanings. 
Strictly  speaking,  consolidated  mortgages  are  secured  by  a  mortgage  on 
all  the  properties  of  a  number  of  subsidiary  companies  which  have 
been  consolidated.  A  second  use  of  the  consolidated  mortgage  bond  is 
in  the  issuance  of  bonds  to  consolidate  a  number  of  issues,  coming  due 
at  some  future  date,  on  separate  properties  already  consolidated  under 
one  organization.  Provision  in  such  a  mortgage  should  be  made  for  a 
trustee  to  hold  the  amount  unissued  which  is  to  be  used  for  the  retire- 
ment of  maturing  issues.  When  used  for  this  purpose  the  issue  is 
similar  to  a  refunding  issue.  As  in  refunding  issues,  provision  is  also 
generally  made  for  an  amount  to  be  expended  in  improvements  and 
extensions  at  a  certain  ratio  to  the  cost  of  these  improvements.  These 
expenditures  should  always  be  capital  expenditures. 

If  mortgages  are  already  outstanding  on  the  separate  properties, 
the  consolidated  mortgage  is  subsequent  in  lien  to  these  mortgages,  and 
is  in  relatively  the  same  position  as  a  general  mortgage.  If  no  mort- 
gages are  outstanding  on  the  several  properties,  the  consolidated  inert- 


APPENDIX  679 

gage  is  a  first  lien  and  in  the  same  position  as  a  first  mortgage.     The 
consolidated  issues  have  been  used  almost  wholly  by  railroads. 

The  priority  of  the  liens,  under  the  division  of  the  character  of  the 
lien,  is  relative,  and  it  is  in  this  particular  division  that  the  descriptive 
title  must  be  especially  checked  with  the  description  of  the  mortgage. 
In  this  regard  the  general  classes  of  the  consolidated,  the  refunding 
and  the  general  mortgage  issues  are  apt  to  prove  the  most  troublesome. 
It  is  a  very  common  practice  to  use  all  three  of  these  classes  for  the 
purpose  of  retiring  outstanding  issues.  The  consolidated  mortgage,  in 
its  simplest  form,  is  secured  by  properties  consolidated  under  one  com- 
pany. When  it  is  subject  to  a  number  of  mortgages  on  the  various 
companies  consolidated,  it  is  the  same  as  a  general  mortgage  which  is 
a  general  or  blanket  lien  on  all  of  the  properties.  If  provision  is  made 
in  either  of  the  issues,  as  well  as  the  refunding  issues,  to  replace  all 
issues  prior  to  them,  it  eventually  becomes  a  first  mortgage  bond.  The 
term  consolidated  mortgage  bonds  is  also  loosely  used  in  practice. 
Where  the  issue  refunds  the  various  mortgages  on  an  already  consoli- 
dated property,  it  is,  strictly  speaking,  a  refunding  issue,  and  where  the 
issue  is  the  first  of  its  kind,  as  a  first  consolidated  mortgage,  it  must 
not  be  taken  for  a  first  lien  issue;  it  is  only  the  first  consolidated  issue 
which  is  outstanding  upon  the  properties. 

Regardless  of  the  technical  differences  and  the  similarity  between 
the  refunding,  the  general,  and  the  consolidated  issues,  they  denote  the 
common  trend  toward  the  simplification  of  mortgage  issues  which  is 
commented  upon  elsewhere.  As  consolidations  cannot  continue  with  the 
same  frequency  in  the  future  as  in  the  past,  because  of  the  limits  placed 
upon  them  by  state  regulations,  the  refunding  and  general  mortgage  will 
be  in  the  ascendency.  The  former  seems  to  be  the  more  commonly 
favored  at  present. 

The  open-end-mortgage,  as  referred  to  in  the  discussion  of  refunding 
issues,  has  become  one  of  the  important  features  in  many  mortgages  in 
the  last  ten  years.  This  clause  allows  the  company  to  issue  additional 
bonds  of  an  authorized  mortgage  having  a  given  amount  already  issued. 
The  usual  limitation  placed  upon  the  amount  of  the  increase  is  that  it  be 
not  more  than  a  given  per  cent  of  the  cost  of  the  property  purchased 
or  constructed  (most  commonly  75%),  and  frequently  the  added  re- 
quirement that  the  earnings  be  equivalent  to  a  given  number  of  times 
the  interest  charges  on  both  the  outstanding  and  purposed  new  issue. 
This  privilege  leaves  the  company  unhampered  in  its  development  and 
yet  places  upon  it  restrictions  that  should  protect  the  investor  and  in- 
crease the  value  of  his  holding.  The  difficulty  to  date  of  these  "after 
acquired"  clauses,  is  their  trusteeship.  The  common  practice  has  been 
to  accept  the  company's  statement  that  it  has  fulfilled  the  necessary  re- 
quirements. A  more  careful  auditing  and  examination  as  to  the  proper 
fulfillment  of  this  contract,  for  the  protection  of  the  investor,  must  be 


680  INVESTMENT  ANALYSIS 

made  before  the  trustee  can  serve  the  best  interests  of  the  investor. 
Some  of  the  more  recent  mortgages  now  provide  for  the  proper  checking 
up  of  the  company's  financial  status  when  the  company  seeks  to  issue 
additional  bonds  under  this  clause  in  the  mortgage.  Under  proper 
trusteeship,  this  privilege  of  future  issuance  out  of  an  authorized  issue 
must  serve  as  one  of  the  most  valued  additions  to  the  modern  corporate 
mortgage. 

Construction  Bonds. — When  bonds  are  issued  against  properties  in  the 
process  of  construction,  they  are  frequently  called  construction  bonds. 
In  most  -cases   these   construction   bonds   are   replaced   by   permanent 
issues.    The  term  has  never  been  very  exactly  used. 
Continued  Bonds. —  (See  Extension  Bonds.) 

Convertible  Bonds. — Convertible  bonds  are  those  bonds  which  may  be 
converted  into  other  securities,  usually  stock  of  the  same  company  is- 
suing the  bonds.  This  conversion  is,  however,  regulated  by  certain 
requirements  set  forth  in  the  mortgage  instrument.  The  convertible 
bonds  since  1900  have  grown  very  much  in  favor.  The  holder  of  the 
bond  under  the  limitations  in  the  trust  deed,  may,  at  his  own  option, 
convert  his  bond  into  other  securities  of  the  same  corporation.  Some 
few  issues  make  the  conversion  into  securities  of  other  companies 
which  are  generally  allied  to  the  issuing  corporation.  They  have  been 
more  commonly  used  by  railroads,  and  the  bonds  given  the  privilege 
are  usually  debentures  or  some  junior  lien.1  The  conversion  dates  are 
after  a  certain  date  or  within  certain  dates,  and  frequently  both  limi- 
tations are  used.  Most  issues  also  give  the  company  the  right  of  re- 
deeming the  issue  having  the  conversion  privilege  before  maturity  at  a 
premium.  Where  conversion  is  put  some  time  in  the  future,  and  danger 
to  the  company  or  certain  controlling  interests  has  existed  in  wider  con- 
trol, the  company  has  often  called  the  bond  before  the  conversion  privi- 
lege date. 

Mr.  Rollins  has  characterized  these  securities  as  a  "Call"  upon  the 
company's  prosperity.  To  that  degree,  they  have  been  speculative 
risks.  When  the  market  has  been  overloaded  with  issues  or  the  com- 
pany is  in  a  strained  condition,  or  the  market  badly  depressed,  these 
issues  have  been  more  freely  used.  The  periods  of  greatest  activity  in 
the  use  of  these  issues  were  in  1868,  1875,  1893,  1903,  1907,  and  1913. 

A  number  of  strong  companies  forced  to  go  into  the  markets  at 
these  times  for  funds  have  used  them  to  advantage,  while  weaker  com- 
panies at  such  times  have  frequently  been  forced  to  the  use  of  the 


Montgomery  Rollins,  "Convertible  Securities"  (Boston,  1913).  This 
work  gives  a  very  complete  introductory  discussion  of  convertibles,  which 
is  followed  by  a  description  of  all  convertible  issues  in  the  United  States 
with  complete  tables  of  conversion  prices.  Also  see  the  same  author's 
article  in  Annals  of  American  Academy  of  Political  and  Social  Science, 
vol.  xxxv  (1910),  pp.  97-107- 


APPENDIX  681 

short  termed  note.1  In  extensive  new  construction  or  in  financing  under 
any  of  the  foregoing  conditions,  the  convertible  bond  has  been  much 
cheaper  than  either  the  bond  without  this  privilege  or  the  straight  stock 
issue.  As  the  author  just  referred  to  states:  "The  fixed  charges  be- 
come transformed  into  contingent  ones,  with  the  progress  of  the  con- 
version of  bonds  into  stock.  And  this  process  of  conversion  is  automatic 
in  its  actions.  The  plan  in  short  is  that  of  an  automatic  sinking  fund." 

A  corporation,  on  the  other  hand,  may  be  compelled  to  carry  a 
large  interest  charge  in  the  face  of  a  continued  market  depression.  For 
some  corporations,  this  might  seriously  affect  credit,  whereas  with  others, 
it  would  only  depress  the  price  of  the  stock  which  in  turn  would  depress 
the  price  of  the  convertible  bonds  depriving  the  holder  of  his  specu- 
lative advantage.  It  is  a  commonly  accepted  theory,  that  the  relatively 
low  price  of  Pennsylvania  stock  has  been  in  some  measure  due  to  the 
large  amount  of  its  convertible  bond  issues.  As  with  all  bond  issues, 
convertible  bonds  depend  for  their  pure  investment  value  not  upon  the 
privilege  of  conversion  but  upon  the  soundness  of  the  corporation. 

The  price  of  the  convertible  bond  generally  will  follow  the  price 
of  the  stock  into  which  it  can  be  converted  in  an  ascending  market, 
so  that  either  the  sale  of  the  bond  or  its  conversion  into  stock  will  give 
the  advantage  of  the  profit.  In  a  falling  market,  the  price  of  the  bond 
will  follow  the  price  of  the  stock  to  a  certain  point ;  beyond  this,  it 
will  not  follow.  That  is,  the  bond  price  will  not  fall  below  its  own 
investment  basis.  If  the  bond  at  par  can  be  converted  into  stock  at 
120,  and  they  are  both  at  these  respective  prices,  there  is  no  advantage 
in  conversion.  Two  movements  would  make  conversion  profitable.  If 
the  price  of  the  stock  alone  advances,  it  would  be  profitable  to  convert, 
or  if  the  bond  price  alone  drops,  conversion  would  be  profitable.  The 
movements  of  convertible  bonds,  as  a  class,  because  of  this  con- 
version privilege,  have  relatively  greater  range  than  those  of  other 
securities  with  equal  security.2  But  as  pointed  out  in  the  discussion  of 
principles,  whenever  an  advantage  is  secured  in  an  investment  it  must  be 
paid  for  by  an  offset  of  some  other  disadvantage.  Whether  this  privi- 
lege is  the  one  wanted,  must  be  determined  by  each  individual  investor. 
Certainly,  for  the  permanent  investment  of  one  who  is  unfamiliar  with 
the  financial  market,  the  convertible  security  is  not  the  kind  of  invest- 
ment to  be  purchased. 

Convertible  Collateral  Trust  Bonds. —  (See  Convertible  and  Collateral 
Trust  Bonds.) 


JW.  Z.  Ripley,  Railroad,  Finance  and  Organization,  p.  158. 

There  are  so  many  experiences  and  angles  of  approach  which  must 
be  examined  in  a  study  of  convertible  security  prices,  that  it  is  only 
practical  to  state  the  more  common  conditions  affecting  the  general 
movement  of  their  prices.  The  reader  who  is  interested  in  a  more  com- 
plete study  of  convertible  price  movements  is  again  referred  to  Mr. 
Rollins'  articles  and  books. 


682  INVESTMENT  ANALYSIS 

Convertible  Debentures. —  (See  Debenture  Bonds.) 
Convertible  Income  Bonds. —  (See  Income  Bonds.) 
County  Bonds  (*). —  (See  Chapters  on  Civil  Loans.) 
Coupon  Bonds. — Bonds  to  which  interest  coupons  are  attached  can  be 
classed  as  coupon  bonds.  These  coupons  are  interest  certificates  at- 
tached to  the  instrument  of  the  bond  representing  the  principal.  Each 
coupon  attached  represents  the  interest  due  for  a  certain  period,  now 
practically  always  six  months.  The  number  of  coupons  attached  to  a 
bond  is  determined  by  the  duration  of  the  bond.  The  due  date  of  the 
interest  coupon  is  always  stamped  on  its  face,  and  at  maturity  the 
coupon  can  be  cut  off  and  presented  for  payment  at  the  corporation's 
office,  or  a  bank,  or  to  an  individual  acting  as  its  agent.  Coupons  do  not 
ordinarily  have  the  name  of  the  owner  on  them,  so  that  they  pass  with- 
out indorsement  and  are  independent  of  actions  which  bind  the  regis- 
tered principal.  (For  more  complete  discussion  of  Coupon  Bonds,  see 
chap,  viii.) 

Coupon  Notes. — Notes  with  coupons  attached  are  termed  coupon  notes. 
Cumulative  Income  Bonds. —  (See  Income  Bonds.) 

Currency  Bonds. — Bonds  payable  in  lawful  currency  (any  legal  tender) 
can  be  classed  as  currency  bonds. 

Debentures. —  (See  Debenture  Bonds.)  The  term  debentures  is  used  as 
an  abbreviation  for  all  forms  of  corporation  debenture  bonds  or  mort- 
gages. 

Debenture  Bonds  (*). — Corporate  debenture  issues  are  an  unsecured 
claim  against  all  assets  of  a  corporation  with  no  stipulation  as  to 
any  specific  assets.  The  whole  of  the  debenture  group  is  an  adoption 
of  the  English  conception  of  the  value  of  a  mortgage,  namely,  that  the 
value  of  the  bond  depends  directly  upon  the  earning  power  of  the  cor- 
poration. They  are  virtually  formal  promissory  notes.  While  we  shall 
always  retain  the  advantage  of  the  specific  lien,  the  tendency  toward 
the  simplification  and  consolidation  of  issues  is  a  partial  recognition  of 
the  correctness  of  the  English  principle.1 

The  debenture  holder  has  no  specific  claim  against  the  pronm-ty  of  a 
corporation  and  cannot  bring  foreclosure  proceedings.  As  a  preferred 
creditor  he  can  institute  proceedings  for  a  judgment  or  the  appointment 
of  a  receiver.  For  protection  against  additional  mortgages  that  might 
be  given  prior  claims  to  a  debenture  holder's  preferred  claims,  the 
debenture  instruments  now  contain  clauses  that  give  them  a  priority  of 
claim  against  subsequent  issues. 

A  historical  study  of  debentures  in  the  United  States  reveals  the 


'Hartley  Withers  (Stocks  and  Shares,  p.  96),  (advocates  the  advan- 
tage of  the  specific  mortgage  over  the  debenture  in  the  power  of  fore- 
closure). 


APPENDIX  683 

interesting  conclusion  *hat  the  majority  of  these  securities  have  been 
issued  by  corporations  in  either  a  very  weak  or  in  a  very  strong  posi- 
tion. The  use  of  debentures  by  weak  companies  is  easily  explained. 
If  they  were  compelled  to  issue  a  third  mortgage,  or  any  other  junior 
lien,  it  would  either  have  to  be  sold  at  a  large  sacrifice  or  it  could  not 
be  marketed,  so  they  have  been  able  to  use  the  debenture  to  advantage. 
With  the  better  understanding  of  securities,  this  has  become  less  pos- 
sible and  the  market  prices  of  the  weaker  debentures  have  reflected 
this  in  recent  years.  To  companies  of  strong  credit,  in  addition  to 
eliminating  a  specific  mortgage,  debentures  offer  the  advantage  of  being 
retired  without  the  longer  formality  of  the  specific  lien  bonds. 
Debenture  Income  Bonds  (*). — Bonds  which  possess  the  general  lien 
on  assets  as  to  security  of  principal,  as  with  debenture  bonds,  but  with 
the  interest  due  when  earned,  are  termed  debenture  income  bonds.  The 
term  income  bonds  is  often  used  interchangeably  with  debenture  income 
bonds,  but  as  the  former  bonds,  at  times,  have  a  mortgage  lien,  and 
the  latter  issues  do  not,  the  two  titles  should  not  be  used  inter- 
changeably. 

Debenture  Mortgage  Bonds  (*). —  (See  Debenture  Mortgages.) 
Debenture  Mortgages  (*). — The  debenture  mortgages  are  an  old  form 
of  issue  which  are  now  seldom  used.  These  securities  are  issued  upon 
the  security  of  mortgages  and  are  deposited  with  a  trust  company  or 
trustee.  They  are  usually  issued  at  a  lower  rate  than  the  mortgage 
securing  them. 

Deferred  Bonds. — These  bonds  can  be  issued  under  two  entirely  different 
conditions.  First,  the  interest  payments  may  be  deferred  until  after 
some  future  date.  Second,  the  rates  may  gradually  increase  up  to  a 
certain  date  after  which  the  rate  remains  permanently  at  that  amount. 
Delinquent  Tax  Certificates. — These  certificates  usually  have  been  issued 
on  land  against  which  taxes  were  unpaid.  The  uncertainty  of  their  dura- 
tion and  the  difficulties  in  maintaining  the  priority  of  title  have  not 
made  them  very  desirable  for  investment  purposes. 
Development  Mortgages. — A  security  issued  to  secure  funds  for  improve- 
ments, developments,  etc..  is  termed  a  development  security.  It  may 
have  a  first  lien  upon  the  developments,  or  it  may  rank  as  a  junior  lien 
or  it  may  be  in  the  form  of  a  general  mortgage.  (In  the  latter  case 
it  is  generally  called  a  Development  General  Mortgage  Bond. 
Dividend  Snaring  Bonds — (See  Participating  Bonds.) 
Divisional  (or  Division)  Bonds. — These  bonds  are  issued  by  railroads 
or  street  railway  systems  and  are  secured  by  a  mortgage  upon  a  division. 
i.  e.,  part  of  the  system,  but  in  most  cases  they  are  made  a  direct 
obligation  of  the  railroad  corporation.  If  the  bond  is  on  the  property 
of  a  subsidiary  corporation  and  issued  by  the  parent  company,  it  is  also 
a  divisional  bond.  If  it  is  a  bond  on  a  subsidiary  company  and  it  is 


684  INVESTMENT  ANALYSIS 

assumed  by  the  parent  company,  it  is  often  called  a  divisional   bond, 
though  strictly  speaking,  it  is  an  assumed  bond. 
Dock  Bonds. —  (See  Wharf  Bonds.) 

Drainage  Bonds  (*). — These  bonds  are  usually  issued  by  specially 
created  Municipal  Districts  for  the  purpose  of  reclaiming  the  area 
included  withia  the  district  by  constructing  adequate  drainage  facilities. 
Drawn  Bonds. —  (See  Callable  Bonds.) 

Electric  Light  Bonds  (*). —  (See  Chapter  on  Electric  Light  and  Power 
Bonds.) 

Equal  Installment  Bonds  (*). — These  bonds  are  paid  off  in  equal  install- 
ments. When  the  principal  and  interest  payments  have  been  equally 
distributed  in  serial  payments,  the  allotment  to  the  interest  payment 
grows  smaller  and  the  amount  available  for  the  principal  to  be  retired 
becomes  larger. 

Equipment  Bonds  (*). — When  the  equipment  is  sold  to  the  railroad  on 
conditional  sale,  the  title  is  assigned  to  a  trustee  and  bonds  are  issued 
against  the  equipment.  As  the  railroad  can  have  no  claim  to  title  until 
the  complete  obligation  is  paid,  the  holder  has  a  complete  claim  against 
the  title  of  the  equipment  assigned  to  the  trustee.  WTith  the  final  pay- 
ment of  the  last  installment  of  the  obligation,  the  title  passes  to  the 
railroad  company.  (See  Chapter  on  Equipment  Securities.) 
Express  Company  Bonds. — These  bonds,  which  are  issued  by  Express 
Companies,  are  limited  in  number.  There  are  only  four  large  express 
companies  in  the  United  States. 

Extended  Bonds. — When  the  payment  of  the  principal  of  a  bond  has 
been  extended  to  some  future  date  by  mutual  agreement  of  the  com- 
pany and  holders  of  the  bond,  the  latter  is  termed  an  extended  or 
continued  or  renewal  bond.  As  a  rule  this  extension  privilege  is 
stamped  on  the  old  certificate.  The  security  remains  the  same.  The 
reason  for  the  extension  may  be  to  avoid  the  necessity  of  refunding  into 
a  new  issue  or  to  await  a  more  opportune  market  to  float  a  new  loan. 
Extension  Bonds. — Extension  bonds  are  practically  always  secured  Ly  a 
first  lien  upon  an  extension  of  a  railroad,  and  are  usually  guaranteed 
by  the  issuing  corporation,  and  the  extension  bond  is  made  a  general 
obligation  against  the  company.  These  bonds  are  not  infrequently  used 
to  provide  funds  for  other  parts  of  the  property.  When  other  property 
is  also  given  as  security,  they  are  subject  to  the  existing  liens.  The 
amount  issued  should  be  fixed  at  some  ratio  to  the  cost  of  construction. 
The  majority  of  companies  make  this  75  per  cent.  The  authorized 
amount  unissued  is  made  subject  to  the  same  regulations  when  issued. 
Farm  Mortgage  Bonds  (*). — Bonds  secured  by  a  farm  mortgage  or  mort- 
gages, come  under  this  classification.  It  is  a  common  practice  now  for 
large  dealers  in  farm  mortgages  to  issue  bonds  on  farm  mortgages.  A 


APPENDIX  685 

clause  in  the  contract  permits  the  dealer,  or  corporation,  to  replace  the 
maturing  mortgages,  securing  the  bond  with  mortgages  of  equal  value. 
The  issuances  under  the  Federal  farm  mortgage  statutes  are  issued 
under  similar  conditions. 

Ferry  Bonds. — Ferry  bonds  may  be  issued  by  an  independent  ferry  com- 
pany on  its  ferry  boats  and  other  property,  though  independent  ferry 
companies  are  more  commonly  organized  by  a  terminal  or  railroad 
company  for  the  purpose  of  constructing  ferry  boats  or  wharves. 

First  and  Consolidated  Mortgages. — The  "First"  indicates  a  first  lien. 
How  much  of  the  property  is  included  under  the  lien  can  be  ascertained 
only  by  reading  the  instrument.  The  consolidated  feature  is  upon  the 
whole  or  a  portion  of  the  consolidated  properties  and  is  usually  a  remote 
junior  issue.  (See  Consolidated  Mortgages  and  First  and  Refunding 
Mortgage  Bonds.) 

First  and  General  Mortgage  Bonds. — Bonds  which  are  a  first  lien  on  a 
part  of  the  property  and  a  general  lien  on  all  of  the  remainder  of  the 
property  would  come  under  this  classification. 

First  and  Refunding  Mortgage  Bonds. — This  bond  is  a  first  mortgage 
upon  a  part  of  the  corporation's  property,  as  indicated  by  "First,"  and 
also  is  used  to  refund  other  outstanding  issues,  which  are  likely  to  be 
junior  issues.  This  is  one  of  the  best  examples  of  the  inexactness  of 
our  bond  terminology.  Many  purchasers  have  interpreted  the  prefix 
"First"  as  indicating  an  entire  first  lien,  when  as  a  matter  of  fact,  the 
lien  may  be  on  a  very  small  proportion  of  the  property. 
First  Consolidated  Mortgage  Bonds. — These  bonds  are  the  first  con- 
solidated issues  made  by  a  corporation.  (See  Consolidated  Mortgage 
Bonds.) 

First  General  Mortgage  Bonds.— -These  bonds  are  the  first  general  mort- 
gage bonds  which  have  been  placed  upon  the  property.  Their  lien  can  be 
determined  only  by  reading  the  mortgage  instrument. 

First  Mortgage  Bonds. — Bonds  secured  by  a  first  mortgage  are  included 
in  this  division.  These  bonds  should  not  be  judged  on  the  merits  of  the 
term  "first"  but  on  the  equities  securing  the  bond.  First  mortgage 
bonds  are  not  always  a  lien  on  all  of  the  property  of  a  company.  As 
a  company  expands,  the  first  mortgage  only  continues  as  a  claim  on  its 
original  security.  If  other  properties  are  purchased  and  merged  or  a 
consolidation  is  made,  other  first  mortgages  or  liens  may  exist,  distinct 
from  this  one,  on  other  portions  of  the  company's  properties. 
First  Liens. —  (See  First  Mortgages.) 

First  Lien  and  General  Mortgage  Bonds. — The  "first"  lien  means  a  first 
claim  on  a  part  of  the  property  and  the  second  part  of  the  issue  indi- 
cates that  it  has  a  general  claim  on  the  property  which  is  a  junior 
issue.  (See  First  and  Refunding  Mortgage  Bonds.) 


686  INVESTMENT  ANALYSIS 

First  Mortgages. —  (See  Mortgage,  First  Mortgage  Bonds  and  Second 
Mortgages. ) 

First  Mortgage  Trust  Bonds. — First  mortgage  trust  bonds  are  bonds 
secured  by  a  lien  on  bonds  deposited  as  security,  which  are  secured  by 
a  first  lien.  (See  Collateral  Trust  Bonds.) 

First  Refunding  Mortgage  Bonds. — The  first  refunding  bonds  are  the 
first  refunding  bonds  issued  by  a  corporation.    Their  lien  depends  upon 
the  issue,  or  issues,  which  the  refunding  bonds  replace.    A  part  of  the 
issue  may  replace  a  first  mortgage,  but  not  necessarily  so. 
Firsts. —  (See  First  Mortgage  Bonds.) 

First  Trust  Mortgages. —  (This  is  a  vague  and  illegitimate  use  of  a  mort- 
gage title.) 

Founders  Bonds. — These  bonds  were  originally  issued  by  English  com- 
panies to  reimburse  their  promoters,  and  are  similar  to  bonus  bonds. 
In  a  few  issues  the  meaning  is  quite  distinctly  different  from  the  more 
common  use  of  the  term.  This  is  when  the  issue  is  made  to  pay  the 
original  holder  or  owners  for  the  property  purchased  from  them  by  a 
corporation. 

Funding  Bonds. — Funding  bonds  are  issued  for  the  purpose  of  issuing, 
in  the  form  of  a  permanent  debt,  an  outstanding  floating  debt,  which 
may  consist  of  several  issues.  The  practice  in  funding  floating  debts 
is  to  await  the  advantage  of  a  favorable  market.  Both  municipalities 
and  private  corporations  make  use  of  these  issues. 

Funding  and  Real  Estate  Mortgage  Bonds  (*). — A  corporation,  in  the 
issuance  of  these  bonds,  has  usually  selected  a  small  part  of  its  real 
estate  and  made  it  a  first  lien  for  a  portion  of  the  issue  while  a  part 
of  the  issue  is  generally  used  in  funding  other  obligations.  While  the 
first  lien  is  not  necessary  to  the  issue  it  is  practically  always  used  be- 
cause of  the  higher  price  realized. 

Gas  Company  Bonds  (*). —  (See  Chapter  on  Gas  Bonds.) 
General  and  First  Mortgage  Bonds. —  (See  General   First  Mortgage 
Bonds.) 

General  First  Mortgage  Bonds. — This  bond  is  merely  a  general  mortgage 
bond;  its  lien  depending  on  mortgages  already  outstanding.  First  has 
no  significance.  If  the  qualifying  word  "and"  is  found  between  Gen- 
eral and  First,  the  mortgage  will  usually  have  a  first  claim  on  a  small 
part  of  the  property. 

General  Mortgage  Bonds. — The  lien  of  these  bonds  is  a  general  claim 
upon  all  the  property  of  a  corporation  subject  to  the  lien  of  previous 
issues,  which  may  vary  from  a  first  claim  to  the  more  remote  junior 
liens.  This  type  of  bond  has  almost  entirely  replaced  the  blanket 
mortgage  bond,  which  is  similar.  This  bond  is  chiefly  used  by  railroads. 
Gold  Bonds. — Bonds  payable  in  United  States  gold  coin  of  the  standard 


APPENDIX  687 

weight  and  fineness  of  the  existing  standard  can  be  classed  as  gold 
bonds. 

Guaranteed  Bonds. — Any  bond  which  is  guaranteed  by  another  cor- 
poration, individual,  etc.,  is  a  guaranteed  bond.  This  guarantee  may  be 
only  on  the  principal,  or  the  interest,  or  both.  If  the  guarantee  is 
made  soon  after  the  issue,  an  indorsement,  together  with  the  guarantee, 
is  made  on  the  guaranteed  bond  by  the  proper  official  of  the  guaran- 
teeing company.  The  confusion  that  exists  between  the  assumed  and 
the  guaranteed  bonds,  which  are  often  taken  as  one  and  the  same, 
calls  for  special  comment.  When  one  company  has  been  taken  over 
by  another  company,  the  obligations  are  assumed,  the  same  as  the 
property.  If  the  company  is  absorbed,  the  mortgages  of  the  company 
taken  over  become  as  much  a  part  of  the  obligations  of  the  company 
assuming  them,  as  if  they  were  obligations  that  had  been  issued  directly 
by  the  company  itself.  All  bonds  assumed  follow  the  order  of  their  lien 
at  the  time  they  are  assumed.  Where  one  company  has,  for  example, 
leased  the  properties  of  another  company,  it  may  guarantee  the  prin- 
cipal or  interest,  or  both.  The  value  of  the  guaranteed  security  de- 
pends upon:  (1)  the  validity  and  terms  of  the  contract;  (2)  the  value 
of  the  lease  to  the  leasor ;  (3)  the  ability  of  the  guaranteeing  company 
to  pay  and  the  earning  power  of  either  company  as  an  independent 
enterprise;  and  (4)  the  duration  of  the  guarantee. 

The  majority  of  these  guarantees  are  of  older  issues  and  many  of 
them  were  not  well  framed.  In  a  number  of  contracts,  where  the  lease 
proved  to  be  a  losing  proposition,  these  loose  contracts  permitted  the 
corporation  to  overthrow  its  contract.  Others  have  never  been  legally 
tested.  Guaranteed  common  stocks,  being  much  more  numerous  and 
more  speculative,  have  had  more  unfortunate  experiences  than  guar- 
anteed bonds. 

A  number  of  years  ago  guaranteed  securities  were  in  much  de- 
mand. In  recent  years,  the  prices  of  many  of  these  securities,  especially 
stocks,  have  fallen  as  compared  to  other  stocks  and  in  comparison  with 
their  former  high  price.  Certain  guaranteed  stocks  probably  offer  one 
of  the  best  illustrations,  outside  of  Federal  government  bonds,  of  the 
influence  of  an  artificial  market.  A  study  of  guaranteed  bonds  leads 
to  the  same  conclusion,  except  that  the  range  in  prices  has  been  within 
narrower  limits.1 

Improvement  Bonds  (*). — These  bonds  are  usually  a  charge  against 
the  property  which  the  improvements  abut.  In  a  few  states,  they  are 
direct  municipal  obligations ;  in  others,  the  city  is  responsible  for  them, 
if  the  payment  of  the  bonds  is  defaulted  by  the  abutting  property  owners. 
This,  as  far  as  the  investor  is  concerned,  makes  them  a  direct  obligation 
of  the  city.  All  bond  issues  for  improvements  for  streets,  pavements,  sew- 
ers, etc.,  would  be  classed  under  improvement  bonds. 


Unpublished  lectures  of  Spencer  Trask  &  Co.,  New  York. 


688  INVESTMENT  ANALYSIS 

Income  Bonds. —  (See  Debenture  Income  Bonds,  which  Is  the  com- 
plete title  for  Income  Bonds.)  These  bonds  may  have  a  specific  lien, 
though  not  -necessarily  so ;  but  the  interest  payments  are  qualified  by 
the  requirement  "when  earned,"  *.  e.,  can  only  be  paid  when  earned — 
a  point  which  is  determined  by  the  directors.  The  interest  may  be 
cumulative  or  non-cumulative.  If  cumulative,  the  interest  payments 
not  met  in  a  particular  year  continue  as  a  charge  against  the  company. 
The  variation  in  the  interest  payments  on  income  bonds  necessitates  a 
careful  examination  of  these  regulations. 

The  preference  income*1  bonds  are  given  certain  rights  over  other 
issues,  and  in  non-payment  of  either  interest  or  principal,  or.  both,  they 
are  sometimes  given  mortgage  rights. 

Indorsed  Bonds. — Coupon  bonds,  which  are  payable  to  bearer,  and  have 
an  indorsement  upon  them   which   does   not  pertain  to   the   security, 
must  be  sold  by  a  member  of  the  New  York  Stock  Exchange  if  sold 
through  the  Exchange  as  indorsed  bonds,  in  order  to  be  a  good  delivery. 
Bonds  of  one  corporation  which  are  indorsed  by  another,  as  a  guar- 
antee of  payment,  are  also  called  indorsed  bonds. 
Industrial  Bonds  (*). —  (See  Chapter  on  Industrial  Bonds.) 
Installment  Bonds. — These  bonds  are  retired  by  installment  on  certain 
interest  dates.    Customarily  these  amounts  are  equally  distributed  over 
the  life  of  the  bonds.     (See  Serial  Bonds.) 

Intercepting  Seicer  or  Improvement  Bonds. — When  a  part  of  the  ex- 
pense for  a  sewer  system  or  other  improvement  is  charged  against  the 
abutting  property,  and  the  other  against  the  municipality,  the  bonds 
issued  by  the  latter  are  known  as  an  intercepting  bond  issue.  (A 
Sewer  Trunk  issue  is  a  bond  issue  providing  for  the  main  sewer  line 
with  which  the  individual  street  sewers  connect.) 

Interim  Certificates. — These  certificates  are  temporary  certificates  issued 
to  the  purchaser  of  a  security  by  the  corporation,  though  more  fre- 
quently by  a  trust  company,  until  the  permanent  certificates  can  be 
issued.  This  fact  is  stamped  upon  the  certificates  (may  be  printed  or 
typewritten). 

Interchangeable  Bonds. — When  the  privilege  is  extended  to  the  holder 
of  coupon  bonds  to  exchange  them  for  registered  bonds,  or  vice  versa, 
they  are  called  interchangeable  bonds.  When  a  coupon  bond  has  been 
exchanged  for  a  registered  bond,  it  is  not  uncommon  to  restrict  any 
further  exchanges.  (See  chap,  viii.) 

Interuroan  Railway  Bonds  (*). —  (See  Chapter  on  Street  Railway  and 
Interurban  Bonds.) 

Irredeemable  Bonds. — Very  few  of  these  bonds  have  been  issued  in  the 
United  States.     Great  Britain  in  the  past  marketed  a  number  of  these 
securities. 
irrigation  Bonds  (*). —  (See  Chapter  on  Irrigation  Bonds.) 


APPENDIX  689 

Joint  Bonds.— vThese  bonds  are  joint  obligations  of  two  or  more  different 
corporations,   though   they   are  most   commonly   secured   by    the   same 
property.     When  collateral  securities  are  deposited  as  security,  these 
bonds  are  correctly   termed   joint  collateral  trust   bonds,   though  fre- 
quently the  name  is  abbreviated  to  collateral  trust  bonds.    These  must 
not  be  confused  with  the  bonds  issued  by  one  company  and  later  guar- 
anteed by  two  or  more  companies.    The  latter  are  indorsed  bonds. 
Joint  Collateral  Trust  Bonds. —  (See.  Joint  Bonds.) 
Joint  Mortgages. —  (See- Joint  Bonds.) 

Judgment  Bonds. — These  bonds  are  issued  to  meet  an  obligation  which 
has  been- adjudged  as  valid  by.  the  court 

Junior  Mortgages. — These  are  mortgages  over  which  another  mortgage 
or  mortgages  have  priority. 

Land  Grant  Bonds. — These  bonds  are  secured  by  land  granted  to  the 
corporation  by  the  government.  A  sinking  fund  for  the  retirement  of 
these  bonds  was* practically  always  accumulated  out  of  the  sale  of  these 
lands.  They  were  issued  by  the  railroads  in  the  early  days  of  railroad 
construction.  Canadian  railroads  have  made  use  of  this  bond  in  recent 
years. 

Land  Grant  Certificates. —  (See  Land  Grant  Bonds.) 
Leasehold  Mortgage  Bonds  (*). — In  Chicago,  where  this  bond  has  had 
its  greatest  development,  the  bond  issue  is  made  upon  the  building  and 
the  leasehold  right.    The  latter  is  usually  made  for  99  years. 
Legal  Tender  Bonds. — All  bonds  which  are  designated  as  payable  in 
legal  tender  of  the  country  may  be  called  legal  tender  bonds. 
Levee  Bonds   (*). — These  bonds  are  in  the  general  class  of  irrigation 
and  drainage  bonds,  which  are  usually  issued  by  a  specially  created 
municipal  district,  for  the  purpose  of  protecting  an  area  against  over- 
flow waters. 

Mining  Bonds. — These  bonds  are  issued  on  mining  properties.     There 
are  very  few  bonds  issu,ed  on  strictly  mining  properties ;  smelting  plants 
and  other  properties  are  usually  included  under  the  lien,  a  fact  which 
makes  them,  partially  at  least,  largely  industrial  issues. 
Mortgage  Bonds  (*). — These  bonds  constitute  "a  promise  to  pay  in  the 
form  of  bonds  and  are  secured  by  a  mortgage  on  property." 
Mortgage-Collateral  Trust  Bonds. —  (See  Collateral  Trust  Bonds.) 
Mortgage  Debentures. —  (See  Debenture  Bonds.) 

Mortgage  Income  Bonds. — Income  bonds  are  those  bonds  whose  principal 
has  a  specific  claim  against  assets  (the  priority  of  the  claim  must  be 
ascertained  from  the  instrument).  These  bonds  are  often  designated  as  to 
their  order  of  issue  by  "First,"  etc. 

Municipal  Mortgage  Bonds  (*). — In  a  few  of  these  bond  issues  a 
specific  lien  is  given  by  a  municipality  upon  revenue  producing  property. 


690  INVESTMENT  ANALYSIS 

The  distinction  is  not  important,  however,  as  the  payment  of  the  bond 
and  its  interest  is  dependent  upon  the  same  sources  as  are  general 
municipal  bonds. 

National  Bonds  (*). —  (See  Chapter  on  Government  Bonds.) 
Notes. — Notes,  like  certificates  of  indebtedness,  differ  from  ordinary 
promissory  notes  only  in  their  more  formal  character.  They  are 
assumed  by  corporations  desiring  funds  for  shorter  periods  than  the 
normal  duration  of  the  bond  issues,  or  the  corporation  makes  the 
temporary  note  issues  for  the  purpose  of  awaiting  a  more  propitious 
market  for  a  long  time  bond  issue.  Railroads  have  made  frequent  use 
of  notes  under  the  latter  conditions.  They  are  most  frequently  secured 
by  collateral,  as  this  simplifies  the  creation  of  a  new  issue  and  gives 
them  a  better  market. 

Optional  Bonds. — The  corporation  issuing  these  bonds  has  the  right, 
at  its  own  option,  of  paying  the  bonds  off  before  the  regular  maturity 
date.  The  majority  of  these  bonds  are  redeemable  at  option  after  a 
given  date.  They  are  then  frequently  called  "Optional  After." 

In  a  number  of  the  real  estate  issues  the  holder  of  the  bonds  after  n 
given  date  has  the  privilege  of  surrendering  the  bonds  and  receiving  the 
amount  of  the  principal  paid  in   plus  interest    (usually  3%)    for  the 
period  during  which  the  corporation  has  had  the  use  of  these  funds. 
Overlying  Mortgages. — A  mortgage  over  which  one  or  more  mortgages 
may  have  precedence  is  termed  an  overlying  mortgage. 
Participating  Bonds. — A  minimum  interest  rate  is  usually  fixed  on  these 
l;onds  and  the  bonds  then-  participate  in  the  earnings.     The  amount  of 
this  participation  may  be  unlimited  or  fixed. 

Paving  Bonds. —  (See  Improvement  and  Special  Assessment  Bonds.) 
Perpetual  Bonds. — Bonds  which  have  no  maturity  of  the  principal  are 
termed  perpetual  bonds.  Except  for  a  few  old  issues  they  are  not 
found  in  this  country-  They  are  no  longer  considered  a  desirable  type  of 
issue  because  being  at  an  indefinitely  fixed  rate  makes  them  inadaptable 
to  long  time  changing  markets. 

Plain  Bonds. — Plain  bonds  are  theoretically  bonds  without  a  specific 
lien.  (Where  the  title  is  correctly  used,  they  are  the  same  as  Deben- 
ture Bonds.) 

Preference  Income  Bonds. —  (See  Income  Bonds.) 

Preference  Income  Bonds,   or  Preference  Bonds. — The  title  of  these 
bonds  is  used   interchangeably   with   the  term   income  bonds.     When 
there  is  a  desire  to  differentiate  several  series  as  to  the  priority  of  their 
claims,  this  title  is  often  used. 
Preferential  Bonds. —  (See  Prior  Lien  Bonds.) 
Premium  Bonds. — Bonds  of  municipalities  and  corporations  are  occn- 


APPENDIX  691 

sionally  retired  at  a  premium.  When  bonds  are  made  callable,  it  is 
also  a  common  practice  to  retire  them  at  a  premium. 
Prior  Lien  Bonds. — Strictly  used,  this  title  should  indicate  a  prior 
claim  over  all  other  issues  outstanding  against  a  property.  The  title, 
however,  is  so  frequently  used  to  indicate  priority  over  certain  specified 
issues  that  it  is  no  longer  dependable.  An  examination  of  the  exact 
lien  of  each  issue  is  necessary. 
Profit  Sharing  Bonds. —  (See  Participating  Bonds.) 
Purchase  Line  Mortgages. — When  a  railroad  corporation  purchases 
additional  mileage  it  frequently  will  issue  bonds  secured  by  this  line 
for  the  purpose  of  providing  money  for  the  purchase  of  the  property. 
The  only  security  that  the  holder  of  these  bonds  has  is  the  line  pur- 
chased. The  issuing  corporation  has  no  obligation  unless  it  guarantees 
the  issue,  or  additional  security  is  offered.  This  necessitates  the 
examination  of  the  status  of  the  purchased  line.  This  method  of 
financing  is  employed  where  restrictions  exist  which  prevent  the  pur- 
chasing company  from  issuing  bonds  or  securities  on  the  purchased  fines, 
or  the  "after  acquired  clause'  of  the  mortgage"  prevents  further  indebted- 
ness. 

Purchase  Money  Bonds. — The  only  distinction  between  these  bonds  and 
the  "Purchase  Line  Mortgages''  is  that  they  may  be  issued  on  any 
property  purchased  by  a  corporation,  such  as  a  manufacturing  plant. 
These  bonds  are  also  used  in  exchange  for  the  stocks  of  another  cor- 
poration of  which  it  desires  to  secure  control  or  they  may  be  issued  to 
an  individual  owner  for  property. 

Railroad  Aid  Bonds. — These  bonds  were  issued  by  minor  civil  divisions 
of  the  state,  and  in  a  few  still  earlier  cases  by  states,  to  assist  in  the 
building  of  railroads  within  their  territory.  The  issuance  of  these 
bonds  is  chiefly  confined  to  the  period  of  early  railroad  development. 
A  number  of  issues  were  also  made  to  assist  private  enterpries  during 
the  same  period,  but  they  fell  into  even  worse  disrepute  than  the 
railroad  aid  issues.  The  great  number  of  early  repudiations  due  to 
their  illegal  issuance  has  left  these  bonds  in  very  bad  repute  and  they 
are  still  a  very  questionable  form  of  investment. 
Railroad  Bonds  (*). — (See  Chapters  on  Railway  Securities.) 
Railway  Trust  Bonds  (*). — These  bonds  must  not  be  confused  with  the 
"Equipment  Trust  Bonds"  which  are  an  entirely  different  form  of  issue. 
The  Railway  Trust  bond  is  only  a  particular  kind  of  "Collateral  Trust 
Bonds." 

Real  Estate  Bonds  (*). —  (See  Real  Estate  Mortgage  Bonds). 
Real  Estate  Mortgage  Bonds   (*). — Any  bond  secured  by  a  lien  upon 
real  estate  would  be  classed  as  a  "Real  Estate  Mortgage  Bond."     The 
title  is  loosely  used  and  the  student  is  referred  to  the  more  complete 


692  INVESTMENT  ANALYSIS 

discussion  of  this  subject  of  classification  in  chapters  on  "Real  Estate 
Securities." 

Receiver's  Certificates. — When  a  corporation  passes  into  receivership 
the  court  takes  charge  of  its  operation.  During  this  period  of  operation 
any  form  of  a  term  obligation  to  secure  funds  is  issued  by  authority  of 
the  court  as  "Receivers'  Certificates."  These  securities  have  precedence 
over  all  other  obligations,  except  wages  and  current  operating  expenses. 
In  the  final  settlement  and  reorganization  of  the  corporation,  their 
claims  must  be  paid  in  cash,  or  satisfactory  exchange  be  made  in  new 
securities.  Receivers'  certificates  are  usually  issued  only  for  current 
operation  and  for  the  more  essential  permanent  expenses  necessary  for 
public  welfare  in  the  operation  of  the  property.  .Receivers'  certificates 
which  are  also  a  general  claim  against  assets  are  an  exception  to  these 
general  statements  of  debentures.  As  they  are  issued  by  the  court, 
in  order  to  continue  the  operation  of  the  property  for  the  public  wel- 
fare or  interest,  they  of  necessity  must  be  given  this  priority  by  law. 
Current  expenses  and  wages,  alone,  have  precedence.  If  they  are  not 
paid  at  the  end  of  the  receivership,  they  must  be  satisfactorily  adjusted 
in  reorganization. 

Reclamation  Bonds  (*). — Reclamation  bonds  are  issued  for  the  purpose 
of  redeeming  waste  or  overflowed  lands.  (Drainage,  Irrigation  and 
Levee  Bonds.) 

Redeemable  Bonds. —  (See  also  Callable  BondsO  In  the  redeemable 
feature  of  bonds,  the  interests  of  the  investor  desiring  long  time  holdings 
and  the  interests  of  the  corporation  are  opposed.  To  the  corporation,  it 
is  a  decided  advantage  to  be  able  to  recall  any  outstanding  obligation, 
when  there  is  an  opportunity  of  refunding  it  at  a  lower  rate.  To  the 
investor  who  desires  to  be  relieved  from  care,  the  continued  possibility 
of  retirement  at  unexpected  periods  is  a  disadvantage;  and  further- 
more the  security  is  the  more  desirable  to  him,  if  the  corporation  be- 
comes strong  enough  to  recall  it.  To  the  holder  desiring  the  speculative 
opportunity  together  with  the  investment  privileges,  the  position  is 
reversed  when  the  bonds  are  callable  at  a  premium.  Where  the  securi- 
ties of  a  company  are  in  a  strong  investment  position,  especially,  if  the 
callable  privilege  is  likely  to  be  exercised  by  the  payer,  the  price  of  the 
securities  will  go  to  a  premium  and  they  can  be  sold  in  the  open  market. 
Securities  with  exceptional  investment  strength  have  not  infrequently 
for  a  short  period  gone  above  the  premium  price  on  their  own  invest- 
ment basis.  This  premium,  it  is  argued  by  some,  is  more  than  an  off- 
setting compensation  for  the  disadvantage  of  retirement. 
Redemption  Bonds. —  (See  Refunding  Bonds.) 

Refunding  Bonds. — Refunding  bonds,  as  their  name  implies,  are  issues 
used  to  retire  or  replace  outstanding  bonds.  At  present  there  are  few 
refunding  bond  issues  which  do  not  make  provision  for  additional  funds 
under  the  same  authorization  when  needed.  A  clause  is  usually  inserted 


APPENDIX  693 

in  the  mortgage  which  provides  that  if  any  additional  bonds  are  sold 
under  this  refunding  issue  for  extensions  or  purchases,  a  given  ratio  of 
the  cost  of  construction  of  the  new  extension  made,  to  the  amount  of 
the  issue  sold  must  be  maintained,  and  the  interest  charges  earned  a 
given  number  of  times.  Refunding  issues  have  consequently  come  to 
mean  not  only  a  continuation  of  an  old  debt,  but  an  increase  of  the 
funded  debt.  Where  the  latter  is  warranted,  it  greatly  simplifies  the 
floating  of  the  new  securities  and  protects  the  interests  of  both  the  cor- 
poration and  the  investor. 

To  replace  »an  issue  which  a  corporation  has  used  with  profit  and 
safety  to  itself  is  an  advantage  to  the  corporation,  as  well  as,  to  the 
holder  of  the  original  bonds.  If,  however,  it  is  the  renewal  of  a  loan  of 
an  overbonded  corporation  which  is  merely  warding  off  the  evil  day, 
the  issue  should  not  be  made.  If  the  corporation  under  the  latter  con- 
dition can  be  saved,  some  other  method  of  financing  or  reorganization 
is  necessary ;  if  not,  immediate  receivership  is  usually  the  cheapest 
way  out.  Also  a  refunding  privilege  may  enable  the  corporation  to 
make  an  effectual  reduction  in  its  interest  rates.  This,  of  course,  is  an 
advantage  to  the  corporation  and  not  to  the  creditor  in  his  investment 
yield,  though  it  does  strengthen  the  investment  security  through 
strengthening  the  credit  of  the  corporation. 

While  the  issuance  of  a  refunding  bond  does  not  mean  the  final 
cancellation  of  a  debt  by  a  corporation  it  does  permit  the  exchange  of  the 
existing  debt  for  a  new  form  of  indebtedness.  The  refunding  issues, 
as  a  consequence,  are  commanding  universal  attention,  as  they  more  or 
less  involve  the  problems  of  all  liens,  both  in  the  replacing  of  old  issues 
and  the  placing  of  new  funded  debt  on  corporation  property.  Strictly 
used,  a  refunding  bond  would  merely  be  employed  to  replace  old  issues. 
In  these  days,  however,  few  refunding  bonds  are  issued  that  do  not  make 
further  provision  for  future  funds  to  be  secured  under  the  same  issue, 
when  needed.  This  is  done  by  placing  (in  the  mortgage)  a  clause  pro- 
viding as  stated  above  that,  if  any  additional  bonds  are  sold  for  exten- 
sions, or  purchases,  a  given  ratio  of  the  cost  of  construction  of  the  new 
extension  to  the  amount  of  the  issues  must  be  maintained,  and  that  the 
interest  charges  must  be  earned  a  given  number  of  times. 

A  refunding  issue,  then,  means  not  only  the  continuation  of  a  debt, 
but  usually  an  increase  of  the  luuded  debt.  The  effect  of  these  issues 
upon  the  credit  of  the  corporation  and  upon  the  value  of  the  securities 
always  needs  to  be  carefully  scrutinized.  If  the  issuance  merely  pro- 
longs the  evil  of  an  existing  heavy  obligation,  there  is  no  argument  in 
its  favor.  On  the  other  hand  for  a  corporation  to  pay  off  its  bond 
issues  just  as  it  is  becoming  strongly  established  would  be  equally 
objectionable.  And  lastly,  a  corporation  may  be  able  to  make  an  effec- 
tual reduction  in  its  interest  rates,  if  the  privilege  of  refunding  is  had. 

In  civil  loans,  with  the  exception  of  national  loans,  the  arguments 


694  INVESTMENT  ANALYSIS 

for  refunding  bonds  do  not  apply,  as  the  civil  division  has  no  means  of 
making  profits  from  earnings  as  a  corporation.  On  the  other  hand  the 
burden  of  taxation  in  the  payment  of  interest  under  a  continuous 
refunding  of  an  existing  issue,  is  simply  prolonging  the  obligation  and 
forcing  the  public  to  pay  more  interest  charges. 

Refunding  First  Mortgage  Bonds  (*). — Refunding  issues  are  those 
which  are  used  to  retire  a  first  mortgage  bond  issue.  One  may  not, 
however,  be  the  first  refunding  issue  made  by  the  corporation. 

Registered  Bonds  (*). — When  the  name  of  the  owner  of  the  bonds  ap- 
pears on  the  face  of  the  bond,  it  is  a  registered  bond,  and  cannot  be 
transferred  without  being  indorsed  by  the  payee  and  sent  to  the  trans'' er 
office  of  the  corporation  or  municipality.  A  new  bond  is  then  issued 
to  the  new  owner  in  his  name  by  the  transfer  office  of  the  corporation. 

The  line  indicated  on  the  bond  for  the  name  of  the  transferee  may 
be  left  in  blank  and  the  bond  may  pass  through  several  hands.  Any 
person  holding  the  bond  who  desires  to  do  so  may  then  fill  in  his  name 
and  forward  it  to  the  transfer  office.  As  the  interest  checks  are  mailed 
to  the  person  in  whose  name  the  bond  appears  in  the  company's  book, 
it  is  to  the  advantage  of  the  holder  to  have  his  bond  transferred  in 
time  to  receive  his  interest  payment. 

Registered  Coupon  Bonds  (*). — When  bonds  are  registered  as  to  princi- 
pal alone,  and  the  attached  interest  coupons  are  not,  they  are  regis- 
tered coupon  bonds,  and  the  coupons  are  payable  to  the  bearer. 
Renewal  Bonds. —  (See  Extension  Bonds.)  , 

Residuary  Estate  Bonds. — When  a  person  (not  a  corporation)  has  legal 
claim  to  property,  etc.,  which  the  purchaser  should  make  certain  has 
been  probated,  and  this  property  is  clear  of  any  other  legal  claims,  the 
claimant  can  issue  bonds  against  it.  The  right  of  claim  is  conveyed  by 
the  proper  legal  instrument  which  occupies  the  same  relation  to  its  bonds 
as  does  the  collateral  of  collateral  trust  bonds.  The  equity  demanded 
by  the  purchaser  should  be  sufficient  to  cover  the  longest  possible  life 
of  the  person  mortgaging  his  future  claims.  The  purchaser  is  protected 
in  this  by  the  purchase  of  an  annuity  which  returns  his  money  to  him 
if  the  testator  dies  before  the  maturity  of  the  obligation. 

Revenue  Bonds  or  Notes. — When  a  municipal  corporation  has  need  of 
temporary  funds  to  meet  current  obligations,  revenue  securities  are  fre- 
quently issued.  Revenue  securities,  however,  are  temporary  loans  only, 
und  are  retired  within  a  few  weeks  or  months.  As  these  securities  are 
short-termed,  they  are  usually  issued  as  notes. 

Road  Bonds. — Road  bonds  which  were  formerly  issued  principally  by 
the  county  or  special  assessment  district,  are  now  being  increasingly 
assumed  by  the  state.  (See  also  Improvement  Bonds.) 

Sanitary  District   Bonds. — These   bonds   are   issued   by   civil   districts 


APPENDIX  695 

organized  under  state  laws,  for  the  purpose  of  providing  sanitation,  or 
pure  water,  or  both. 

School  District  Bonds  (*). — In  some  parts  of  the  country,  especially 
the  Middle  West,  the  state  is  geographically  divided  into  school  districts. 
These  units  commonly  correspond  to  the  city  or  town  in  metropolitan 
areas,  and  to  the  township,  or  county,  in  the  rural  areas  where  schools 
are  provided.  In  some  states  these  units  are  created  as  special  assess- 
ment districts ;  in  others,  the  law  makes  special  provision  for  the  creation 
of  these  districts  over  specified  areas  where  schools  are  needed.  These 
districts  have  the  authority  to  issue  bonds  which  are  called  school  bonds. 
Second  Consolidated  Mortgage  Bonds. — These  bonds  are  issued  upon 
the  same  security  as  consolidated  (sometimes  called  first  consolidated) 
bonds,  but  subsequent  to  the  claims  of  the  first  consolidated  or  con- 
solidated bonds.  (See  Consolidated  Bonds.) 

Second  Mortgage  Bonds. — Bonds  secured  by  second  mortgages  are  sub- 
sequent to  first  mortgages,  which  have  prior  claims  on  the  corporation 
for  the  payment  of  interest  and  principal  and  also  a  prior  lien  upon 
the  property. 

Secured  yotes. — These  notes  are  the  same  as  collateral  notes,  i.  e.,  they 
are  secured  by  other  stocks  or  bonds  or  by  both  stocks  and  bonds. 
Serial  Bonds  (*). — The  principal  ol'  these  bonds  is  paid  in  installments. 
This  method  of  paying  a  bond  by  the  issuer  may  be  attached  to  a  bond 
of  any  form  of  a  lien. 

Seicer  Bonds. — Sewer  bonds  are  improvement  bonds,  issued  by  a  munici- 
pality for  the  construction  of  sewers.  They  are  issued  either  as  direct 
obligations  of  the  municipality,  or  as  special  assessments  securities. 
Silver  Bonds. — Silver  bonds  are  bonds  which  are  payable  in  silver  cur- 
rency. These  bonds  are  practically  unknown  in  the  United  States, 
except  for  a  very  few  old  issues. 

Sinking  Fund  Bonds  (*) — All  bonds  may  have  the  sinking  fund  pro- 
vision feature  as  a  part  of  the  provision  regulating  the  issue.  These 
provisions  require  the  setting  aside  of  stated  sums  at  regular  intervals 
for  the  payment  of  all,  or  a  part  of  the  obligation. 

The  fund  set  aside  for  this  purpose  may  be  used  to  purchase  the 
securities  of  the  debt  itself ;  the  securities  to  be  purchased  may  be 
drawn  by  lot  which  is  a  very  objectionable  practice.  Serial  numbers 
may  be  placed  upon  the  bonds,  and  the  specific  date  of  retirement  then 
will  be  known,  or  the  bonds  may  be  purchased  in  the  open  market. 
With  any  good  investment  bond,  if  a  corporation  were  forced  to  buy 
all  of  its  own  bonds  on  the  open  market,  it  might  be  forced  to  pay  an 
exorbitant  premium.  The  experience  of  the  British  in  the  forced  pur- 
chase for  the  sinking  fund  of  Consol  2's  and  the  sharp  upturn  of  the 
price  during  the  nineties,  is  a  good  example  of  this.  The  other  method 
of  handling  the  fund  is  to  retain  it  until  maturity.  Some  mortgages 


696  INVESTMENT  ANALYSIS 

provide  for  the  purchase  of  other  securities.  Lastly,  a  fund  may  be 
deposited  with  a  trustee.  When  no  provision  is  made  for  the  purchase 
of  securities,  corporations  have  followed  the  practice,  after  setting  aside 
the  fund  out  of  earnings,  of  placing  it  back  in  the  properties.  In 
strong  companies  this  gives  added  equity  and  strength.  In  weak  cor- 
porations it  is  a  dangerous  procedure  for  the  interests  of  the  investor. 
Senior  Mortgage. — These  mortgages  have  precedence  over  some  other 
mortgage  or  mortgages.  The  term  is  frequently  used  as  meaning  first 
mortgage,  but  a  senior  mortgage  is  not  necessarily  a  first  mortgage. 
Sinking  Fund  Mortgages  (*). —  (See  Sinking  Fund  Bonds.) 
Special  Assessment  Bonds  (*). — These  bonds  are  issued  by  special  civil 
districts  created  for  the  special  purpose  of  financing  such  improve- 
ments as  street  paving,  sewers,  etc.,  for  the  particular  area  organ- 
ized as  the  special  district.  The  city  as  a  whole  within  which  the 
district  is  situated  is  not  obligated  for  the  payment  of  these  obligations, 
except  where  so  designated. 

Stamped  Bonds. — All  bonds  which  have  had  stamped  on  them  some  new 
condition  which  is  added  after  their  original  issue,  are  called  stamped 
bonds. 

State  Bonds  (*). —  (See  Chapters  on  Civil  Loans.) 

Steamship  Bonds  (*). —  (See  Chapter  on  Great  Lake  Steamship  Bonds.) 
Stock  Interest  Certificates. —  (See  Stock  Trust  Certificates.) 
Stock  Trust  Certificates. — These  certificates  are  usually  issued  to  repre- 
sent the  stock  certificates  of  holders  of  stock  in  a  corporation,  the 
stock  certificates  themselves  being  deposited  with  a  trustee.  The  trust 
certificates  are  usually  given  the  full  power  possessed  by  the  stock  by 
agreement  on  the  part  of  the  stockholders.  Consequently  the  stock  trust 
certificates  merely  represent  the  ownership  of  the  holders  of  a  given  num- 
ber of  shares  of  stock. 

Street  Bonds  (*). —  (See  Improvement  Bonds.) 

Street  Raihcay  Bonds  (*). —  (See  Chapters  on  Street  Railway  Bonds.) 
Subsidy  Bonds. —  (See  Railroad  Aid  Bonds.) 
Tax  Arrearage  Bonds. —  (See  Revenue  Bonds.) 
Tax  Relief  Bonds. —  (See  Revenue  Bonds  or  Notes.) 

Telephone  and  Telegraph  Bonds  (*). —  (See  Chapters  on  Telephone  and 
Telegraph  Bonds.) 

Temporary  Bonds  or  Certificates  or  Temporary  Receipts. — When  the 
issuing  corporation  or  civil  district  desires  to  secure  the  money  from 
the  sale  of  its  securities,  before  the  securities  themselves  are  ready  for 
delivery,  temporary  certificates  or  receipts  are  issued,  which  are  later 
exchanged  for  the  permanent  securities.  In  the  past,  abuse  was  occa- 
sionally made  by  corporations  which  were  organized  for  the  promo- 
tional profits. 


APPENDIX  697 

Terminal  Company  Bonds. — These  securities  are  issued  by  railroad  ter- 
minal companies  and  are  secured  by  terminal  properties,  such  as  stations, 
yards,  and  terminal  tracks.  The  terminal  company  is  usually  owned 
by  a  group  of  railroads.  The  bond  issues  may  also  have  the  additional 
guarantee  of  the  several  railroads  using  the  terminal. 
Territorial  Bonds. — Territorial  bonds  are  those  issued  by  territories  not 
yet  admitted  to  statehood  in  the  union.  Some  of  the  bonds  of  former 
territories  now  admitted  as  states  are  still  outstanding,  as  the  issues 
have  not  yet  matured. 

Third  Consolidated  Mortgages. — Third  consolidated  issues.  (See  Con- 
solidated Mortgages.) 

Third  Mortgage  Bonds. — Bonds  which  have  two  bond  issues  preceding 
them  in  right  of  priority  to  their  lien  can  be  classed  as  third  mortgages. 
Timber  Bonds  (*). —  (See  Chapter  on  Timber  Bonds.) 
Toicn  Warrants. —  (See  Certificates  of  Indebtedness.) 
Township  Bonds  (*). —  (See  Chapters  on  Civil  Loans.) 
Trust  Certificates. —  (See  Stock  Trust  Certificates.) 

Underlying  Mortgages. — Bonds  which  have  precedence  over  some  other 
bond  or  bonds  are  termed  underlying  issues.    Though  they  are  usually 
considered  first  mortgages,  they  are  not  necessarily  so.     This  must  be 
determined  from  the  mortgage  instrument. 
Unifying  Bonds. —  (See  Consolidated  Bonds.) 

Unifying  Mortgage  Bonds. —  (See  Consolidated  Bonds.)  First  and  Uni- 
fying Mortgage  Bonds  (See  First  and  Consolidated  Mortgage  Bonds). 
First  Unifying  Mortgage  Bonds. —  (See  First  Consolidated  Mortgage 
Bonds.) 

United  States— Treasury  Certificates. —  (See  Chapter  of  Government 
Bonds.) 

Water  Bonds  (*).— (See  Chapter  on  Private  "Water  Company  Bonds.) 
Water  Company  Bonds  (*). —  (See  Chapter  on  Private  Water  Company 
Bonds.) 

Water  Poicer  Company  Bonds  (*). —  (See  Chapter  Hydro-Electric 
Securities. ) 

Wharf  and  Dock  Bonds. — These  bonds  may  be  issued  by  either  a  pri- 
vate corporation  or  municipality,  for  the  purpose  of  constructing 
wharves.  Where  several  railroad  or  steamship  lines  are  using  the  same 
wharves,  a  separate  company  is  usually  organized. 


APPENDIX  B 


O 

T3 

a 


a 
O    g 


Q  o 

£4  M 

<r*  "^ 

^S  o 


O 


nr^ 

JL    75           CO  _J  W    >a 

M    '"^              Qj   ~   .^J     tj 

o  w 

0                jg    0)    0!    5J 

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03  rH 

U  d             ^  «m 

Q            j^    tl)     pj     W 

5-J      . 

"H     •  t^   C3   O   *j 

a  »o 

j   CQ 

S 

4)  rH 

fl   O  S   ^   *"*   S  OT 

<    Q 

(M 

S    .• 

~ 

O  *^H    *^     M              ^ 

2ND  LIBERTY  LO 

10-25  YEAB  BON 

Issued  $3,807,805,000. 
"Outstanding  $240,003,: 

O 
a 

03 

03 
4) 
•M 
0 

November  15,  1917. 
November  15,  1942. 

Redeemable  at  govern 
tion  on  or  after  Nov 

io 
y-i 

O 

03 

rH 

C3 

Convertible  into  Sec 
verted  4%s  if  app] 
made  before  Nov.  9,  : 
This  privilege  to  cc 
been  extended  and 
subject  to  terminati 
months'  notice  by  the 
of  Treasury. 

a 

-a 
a 

03 
O> 
-w 

O 

TT 

'    • 

a  .2      n  o  2  J3 

o  eo 

VI  rH 

U    £3         .2  [Q°  3  . 

1 

0         oj   p   0   o 

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§  in" 

»  53  «3  *  «  a 

•<    -^     Q 

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a  a, 

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On  iz; 

,_;  Q  o 
H  a 

0 

8 

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^  r? 

rH 

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LIBERTY 
CONVERT 
15-30  YEAB 

co 
»o 
o 
««• 

60 

a 

.rH 

•O 

p 

•d 

a 

03 

fe 
M" 

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05 

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03 

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"-1  '""'•y         ®   ^  »3  FTJ 

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s_i  t-<  '?  "-1  *—  !  .2  ^  *** 

CO 

8 

X  ^ 

SS 

•Saw  2 

O! 
CO 

IST  LIBERTY  LOAN 

15-30  YEAB  BONDS 

ssued  $1,989,455,550. 
Outstanding  $1,410,074,4 

)xempt  from  all  taxes  (e 
tate  and  inheritance  ts 

4)   4) 

a  a 
a  a 

{eedeemable  at  governm 
tion  on  or  after  June 

O 

Q 

a 

03 

0 
rH 

4> 

a 

lonvertible  into  any  hig 
bond  issued  during  the 
cept  short  term  loans  ] 
six  months  from  date 
issue  of  such  higher  rg 
The  date  of  the  termir 
the  war  shall  be  date 
proclamation  of  the  P 

HH 

W 

o> 
^o 

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1-5  >~5 

w 

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cnu< 

698 


APPENDIX 


699 


to 

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f-i         CO 

to 

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Q 

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l-H 

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a  i 

CD" 

OS 

. 

f  S3 

O 

s  s 

•••*  S 

4TH  LIBERTY 
41/48 

15-20  YEAR  BC 

Issued  $6,964,57 
•Outstanding 
$6,394,354,500. 

o" 

o 
X 

<N  rH 

^    t- 

^  .0 
0   0 

si 

00 

Redeemable  at  s 
ment's  option 
after  Oct.  15, 

O 

•e 

G 
OS 

rH 
'C 

Not  convertible 
any  future  is 

W 

•e 

a    \ 

OS 

fa 

B 

0> 

O 

to 

o 

d 

£ 

to 

O           05 

to 
o 

c 

00 
N 

"S 

3 

rH 

"S  ^ 

a  s 

3RD  LIBERTY  L 

4i/4S 

10  YEAR  BONI 

Issued  $4.175,650 
•"Outstanding 
$3,662,715,800. 

oS 

u 

PQ" 

02 

s 

o 
g 

May  9,  1918. 
September  15,  19 

Not  redeemable  i 
maturity. 

OS 

•O 

G 

OS 

to 

rH 

I 

Not  convertible  i 
any  future  iss 

w 

•a 

G 

oS 

fa 

05 
0 

"o 

1 

d 

°  °  ci 

^i    00    W 

-o 

41   rt  OS 

to 

o    . 
-w  - 

VD  LIBERTY  LOA 
CONVERTED  4i/4 

10-25  YEAR  BOND 

tstanding 
1,085,303,750. 

G 
OS 

fa 

U 
P3* 

OS 

<u 

OS 
rH 

to" 
GO  i-l 

TH     j. 

cs  5 

os"  2 

eemable  at  gov 
tent's  option  01 
fter  Nov.  15,  1 

rH 

O 

•a 

OS 

to 

rH 

;  convertible  in 
ny  future  issu< 

w 

"O 

G 
OS 

00 

0) 

Cl 

n6* 

O 

OS   o 

5  a  os 

cS 

o  * 

'o 

w 
* 

S? 

s  ^ 

CS 

S 

y< 

£ 

IST  LIBERTY  LOAN  — 
SECOND  CONVERTED 

4i/4S 

tISSUE  OP  OCT.  24.  1918 
15-30  YEAR  BONDS 

Bailable  by  converting 
31/28  before  April  24, 
1919. 
Outstanding 
$3,492,150. 

otes  A,  C,  D,  F  and  G. 

GO' 

rH 

5  G 

ecleemable  at  govern- 
ment's option  on  or 
after  June'15,  1932. 

to 
rH 

C 
•0 

G 
OS 

to 
rH 

0 

ot  convertible  into 
any  future  issue. 

w 

G 

OS 

fa 

00 
0 

^o 

4< 

X 

O  r^ 

« 

r? 

S* 

s 

d 

C3   o  **"' 

Q 

00 
£    CO    »  05 

G 

>   SrH 

to 

"3  «j 

.9  ~i 

IST  LIBERTY  LOA 
CONVERTED  4% 

tISSUE  OF  MAY  9.  1 
15-30  YEAR  BOND 

•Outstanding 
$473,089,200. 

oS 
fa 

o" 
« 

"o 

rH      .. 

to 

11 

Redeemable  at  go 
ment's  option  < 
after  June  15, 

Si 

Q 

•o 
c 
eS 

to 

rH 

0 

G 
S 

Not  convertible  i 
any  future  issi 

w 

•o 

G 
eS 

00 

0 

"o 

700 


INVESTMENT  ANALYSIS 


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VICTORY  LIBERTY  I 

3-4  YEAB  NOTES 

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»-i»*i<(^<!i<iP5                  H    1  tri                  IM 

APPENDIX  701 

U.  S.  LIBERTY  AND  VICTORY  LOAN  WAR  BONDS 

SUMMABY 

The  possible  limit  of  income  tax  exemption  on  LIBERTY  LOANS, 
exclusive  of  holdings  of  3%s  and  3%s,  may  consist  of : 
$    5,000  in  the  aggregate  of  First  4s,   First  4Vis,  First  Second  4Vis, 
Second  4s  and  4  Vis,  Third  4Vis,   Fourth  4Vis,  Treasury  Cer- 
tificates, and  United  States  War-Savings  Certificates. 

30,000  of  First  Second  41/4s,  until  the  expiration  of  two  years  after  the 
termination  of  the  war,  as  fixed  by  proclamation  of  the 
President. 

30,000  of  Fourth  41/4s,  until  the  expiration  of  two  years  after  the  ter- 
mination of  the  war. 

30,000  in  the  aggregate  of  First  4s,  First  4 Vis,  First  Second  4Vis, 
Second  4s  and  4Vis,  Third  4Vis,  and  Fourth  4Vis,  as  to  the 
interest  received  on  and  after  January  1,  1919,  until  the  expira- 
tion of  five  years  after  the  termination  of  the  war. 

45,000  in  the  aggregate  of  First  4s,  First  4 Vis,  Second  4s  and  4V4s,  and 
Third  4V4s,  as  to  the  interest  received  after  January  1,  1918, 
until  the  expiration  of  two  years  after  the  termination  of  the 
war ;  this  exemption  conditional  on  original  subscription  to,  and 
continued  holding  at  the  date  of  the  tax  return  of,  two-thirds  as 
many  bonds  of  the  Fourth  Liberty  Loan. 

20,000  in  the  aggregate  of  First  4s,  First  4 Vis,  First  Second  4V4s, 
Second  4s  and  4 Vis,  Third  4 Vis,  and  Fourth  4Vis,  as  to  the 
interest  received  on  and  after  January  1,  1919 ;  this  exemption 
conditional  upon  original  subscription  to,  and  continued  holding 
at  the  date  of  the  tax  return  of,  one-third  as  many  notes  of  the 
Victory  Liberty  Loan,  and  extending  through  the  life  of  such 
notes  of  the  Victory  Liberty  Loan. 


$160,000  Total  Copyrighted  Nov..  1920 

VICTORY  LOAN  NOTES : 

Note  I. — The  3%s  are  exempt  both  as  to  principal  and  interest  from  all 
taxation  (except  estate  and  inheritance  taxes)  now  or  here- 
after imposed  by  the  United  States,  any  State  or  any  of  the 
possessions  of  the  United  States,  or  by  any  local  taxing 
authority. 

Note  J. — The  4%s  are  exempt  both  as  to  principal  and  interest  from  all 
taxation  now  or  hereafter  imposed  by  the  United  States,  any 
State,  or  any  of  the  possessions  of  the  United  States,  or  by 
any  local  taxing  authority,  except  estate  or  inheritance  taxes, 
and  graduated  additional  income  taxes,  commonly  known  as 
surtaxes,  and  excess  profits  and  war-profit  taxes,  now  or 
hereafter  imposed  by  the  United  States,  upon  the  income  or 
profits  of  individuals,  partnerships,  associations  or  cor- 
porations. 


•OUTSTANDING   JUNE   30,   1920 

Otherwise,    Above  Data  Revised  to  Nov.    1,   1920. 


tThe  two  issues  of  First  Converted  4Ms  differ  only  to  the  extent  that  the  issue  of  October 
24th  is  tax  exempt  as  to  the  Interest  on  not  to  exceed  $30,000  bonds  regardless  of  one's  sub- 
scription to  ttie  Fourth  Loan,  whereas  the  issue  of  May  9th  is  tax  exempt  as  to  the  interest 
on  not  to  exceed  $45,000  bonds  in  connection  with  one's  subscription  to  the  Fourth  Loan. 


Not  3.— This  table  also  appears  in  the  Annals  of  the  American  Academy  of  Political  and 
Social  Science,  vol.  Ixxxviii,  March,  1920.  The  above  tables  are  a  revision  of  this  same  table 
by  C.  F.  Childs. 


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APPENDIX  D 

SUGGESTED  TOPICAL  BIBLIOGRAPHY 

[NOTE:    This  bibliography  is  not  intended  to  be  exhaustive, 
though  an  attempt  has  been  made  to  make  it  representative.] 

Investments  (General) 

American  Institute  of  Banking 

Loans    and   Investments    (compiled   by   special   contributors)     (New 

York,  American  Institute  of  Banking  Section  of  American  Bankers' 

Association,  1916,  pp.  304) 
Atwood,  Albert  W. 

Putnam's  Investment  Handbook   (New  York,  G.  P.  Putnam's  Sons, 

1919,  pp.  375) 
Babson,  Roger  W. 

Stocks  and  Bonds,  The  Elements  of  Successful  Investing   (Wellesley 

Hills,  Mass.,  The  Babson  Statistical  Organization,  1912,  pp.  402) 
Burn,  Joseph 

Stock  Exchange  Investments  in  Theory  and  Practice  (London,  Charles 

and  Edwin  Lay  ton,  1909,  pp.  322) 
Chamberlain,  Lawrence 

The  Principles  of  Bond  Investment   (New  York,  Henry  Holt  &  Co., 

1911,  Fourth  Ed.,  pp.  551) 
Clay,  Paul 

Sound  Investing  (Moody  Magazine  &  Book  Co.,  1915,  pp.  371) 
Cleveland,  Frederick  A. 

Funds  and  Their  Uses   (New  York,  Appleton  &  Co.,  Revised,  1917, 

pp.  304) 
Conway,  Thomas  and  Atwood,  Albert  TV. 

Investment  and  Speculation  (New  York,  Alexander  Hamilton  Insti- 
tute Series,  1914,  pp.  511) 
Crozier,  J.  Beattie 

The  First  Principles  of  Investments  (London,  The  Financial  Rev.  of 

Rev.,  1910,  pp.  168) 
Escher,  Franklin 

Practical  Investing  (New  York,  Bankers  Pub.  Co.,  1914,  pp.  177) 
Gibson,  Thomas 

Simple  Principles  of  Investment  (New  York,  Doubleday,  Page  &  Co., 

1919,  pp.  191) 

703 


704  INVESTMENT  ANALYSIS 

Guenther,  Louis 

Investments  and  Speculation  (Chicago,  LaSalle  Extension  University, 

1910,  pp.  396) 
Hall,  Henry 

How  Money  Is  Made  in  Security  Investments   (New  York,  Funk  & 

Wagnalls  Co.,  1911,  5th  Ed.,  pp.  239) 
Henry,  George  Garr 

How  to  Invest  Money  (New  York,  Funk  &  Wagnalls,  1908,  pp.  121) 
Hobson,  J.  A. 

An  Economic  Interpretation  of  Investments  (London,  Financial  Rev. 

of  Rev.,  1911,  pp.  145) 

Investment   Safeguards  "Under  Changing  Conditions    (Fin.   Rev.   of 

Rev.,  vol.  x,  No.  104,  June,  1914,  pp.  639-43) 

Investment  Bankers  Association  Proceedings  (Annual  since  1913) 
Jones,  Edward  D. 

Investment   (New  York,  Alexander  Hamilton  Institute  Series,  1918, 

pp.  351) 
Jordan,  David  F. 

Investments  (New  York,  Prentice-Hall,  1920,  pp.  423) 
Lawson,  W.  R. 

American   Finance    (London,     William     Blackwood    &    Sons,    1906, 

pp.  391) 
Leake,  P.  D. 

What    Constitutes    a    Sound    Investment    (Financial   Rev.    of    Rev., 

August,  1914,  vol.  ix,  No.  106,  pp.  903-918) 
Lipper,  M.  W. 

Investments    (New  York,   Universal  Business   Institute,   1911,   Two 

Volumes) 
Lo  wen  field,  Henry 

Investments  Practically  Considered  (London,  Financial  Rev.  of  Rev., 

1909,  pp.  432) 

All  About  Investments   (London,  The  Financial  Rev.  of  Rev.,  1909, 

p.  290) 

Investments    and   Exact    Science    (The   Investment   Registry,    Ltd., 

1906,  pp.  121) 
Lownhaupt,  Frederick 

What  An  Investor  Ought  to  Know    (New  York,   The  Magazine  of 

Wall  Street,  1913,  pp.  152),    (A  series  of  articles  which  originally 

appeared  in  the  Magazine  of  Wall  Street.) 

Investment  Bonds,  Their  Use  and  Their  Place  in  Finance  (New  York 

and  London,  G.  P.  Putnam  &  Sons,  3  90S,  pp.  253) 
Mead,  Edward  Sherwood 

The  Careful  Investor    (Philadelphia  and  London,  J.   B.   Lippincott 

Co.,  1914,  pp.  2S9) 


APPENDIX  705 

Moody,  John 

The  Art  of  Wall  Street  Investing   (New  York,  The  Moody  Corp., 

1906,  pp.  167) 

The  Investor's  Primer  (New  York,  The  Moody  Corp.,  1907,  pp.  183) 

How  to  Invest  Money  Wisely   (New  York,  The  Moody  Corp.,  1912, 

PP.  177) 
Nelson,  S.  A. 

Bond   Buyer's  Dictionary    (New  York,   S.  A.  Nelson  &  Co.,  1907, 

PP.  174) 
Noyes,  Alexander  Dana 

Forty  Years  of  American  Finance  (New  York  and  London,  G.  P.  Put- 
nam's Sons,  1909,  pp.  418) 
Prendergast,  W.  A. 

Credit  and  Its  Uses  (New  York,  Appleton  &  Co.,  1917,  pp.  361) 
Rolleston,  John 

The  Elements  of  Safe   Investment    (London,   Investment  Registry, 

1916) 
Rollins,  Montgomery 

Money  and  Investments  (Boston,  Dana  Estes  Co.,  2  Ed.,  1910,  pp.  440) 
Scott,  William  A. 

Investment  vs.  Commercial  Banking  (The  Proceedings  of  the  Second 

Annual  Convention  of  the  Investment  Bankers'  Association  of  Amer- 
ica, Oct.,  1916,  pp.  76-88) 
Selden,  G.  C. 

Investing  for  Profit  (New  York,  Magazine  of  Wall  St.,  1919,  pp.  150) 
Smythe,  R.  M.  (Compiler) 

Obsolete  American  Securities  and  Corporations  (New  York,  1904-1911, 

two  volumes,  published  by  R.  M.  Smythe) 
Withers,  Hartley 

Stocks  and  Shares   (New  York,  E.  P.  Dutton  &  Co.,  1911,   Second 

Edition,  pp.  371) 
Young,  T.  E. 

A  Plain  Guide  to  Investments  and  Finance  (London,  MacDonald  & 

Evans,  1909,  pp.  346) 

Accounts  for  Investments  and  Stock  Brokers  Accounts 
Accountant,  The 

The  Investment  Accounts  Reprinted  from  the  Accountant   (London, 

Gee,  1915,  pp.  19) 
Bennett,  Robert  Joseph 

(In)    Corporation  Accounting,  pp.  320-389    (New  York,  The  Ronald 

Press,  1916) 
Saliers,  Earl  A. 

Accounting  and  Investments  (The  Journal1  of  Acct.,  vol  xxiii,  Mar., 

1916,  pp.  161-166) 


706  INVESTMENT  ANALYSIS 

Smith,  Harry  Mason 

Balance  Sheet  Audit  of  Stock  Brokers'  Accounts   (Journal  of  Acct., 

Jan.,  1911,  vol.  xi,  pp.  195-204) 
Sprague,  Charles  E. 

The  Accountancy  of  Investments  (New  York,  The  Ronald  Press  Co., 

1914,  pp.  371) 
Todman,  Frederick  Simpson 

Brokerage  Accounts  (New  York,  Ronald  Press  Co.,  1916,  pp.  338) 
Tovey,  Phillip 

(In)  Prospectuses,  pp.  47-58  (London  and  New  York,  Sir  Isaac  Pit- 
man &  Sons.  Ltd.,  1912) 
Webster,  George  R. 

Methods  of  Writing  Off  Discounts  on  Bonds  (Jour,  of  Acct.,  vol.  xvi, 

Sept.,  1913,  pp.  169-174) 

Bonds 

Annals  of  American  Academy  of  Political  and  Social  Science 

Bonds  as  Investments  (Various  titles,  see  index)    (Annals  of  Amer. 

Acad.  of  Pol.  &  Soc.  Sci.,  vol.  xxx,  No.  1,  Sept.,  1907,  pp.  235) 

Bonds  and  the  Bond  Market  (Various  titles)    (Annals  of  Amer.  Acad. 

of  Pol.  &  Soc.  Sci.,  vol.  Ixxxviii,  No.  177,  Mar.,  1920,  pp.  223) 
Bennett,  R.  J. 

(In)    Corporation  Accounting,  pp.   197-207;  239-278;   305-319    (New 

York,  The  Ronald  Press,  1917) 
Chamberlain,  Lawrence 

(See  Investments,  General) 
Colebrook,  William  A. 

A  Treatise  on  the  Law  of   Collateral   Securities    (Second  Edition, 

Chicago,  George  A.  Callaghan,  1S98,  pp.  814) 
Dewing,  A.  S. 

The  Position  of  Income  Bonds  as  Illustrated  by  Those  of  the  Central 

of  Georgia  Railway    (Quart.  Jour,  of  Econ.,  vol.  xxv,  No.  2,  Feb., 

1911,  pp.  390-405) 
Greene,  T.  L. 

(In)  Corporation  Finance,  pp.  1-63  (New  York  and  London,  Putnam's 

Sons,  1913,  Third  Edition) 
Ignatius,  Milton  B. 

(In)  The  Financing  of  Public  Service  Corporations  (pp.  147-266,  New 

York,  The  Ronald  Press,  1918) 
Lough,  William  H. 

(In)   Business  Finance,  pp.  105-171   (New  York,  The  Ronald  Press 

Co.,  1917) 

Corporation  Mortgage  and  Bonds  (In),  Corporation  Finance,  pp.  119- 

153  (New  York.  Alexander  Hamilton  Institute,  1913) 


APPENDIX  707 

Lownhaupt,  Frederick 

Investment  Bonds,  Their  Issue  and  Their  Place  in  Finance   (New 

York  and  London,  G.  P.  Putnam's  Sons,  1908,  pp.  253) 
Mead,  Edward  Sherwood 

Corporation  Mortgages  and  Deed  of  Trust,  (In)  The  Careful  Investor, 

pp.  50-61;  93-115  (Philadelphia  and  London,  J.  B.  Lippencott,  1914) 

Bonds — Collateral  Trust,  (In)  Corporation  Finance,  pp.  323-357  (New 

York,  D.  Appleton  &  Co.,  1920) 

The   United    States    Steel    Corporation's    Bond    Conversion    (Quart. 

Jour,  of  Econ.,  vol.  xviii,  Nov.,  1903,  pp.  22-53) 
Mitchell,  T.  W. 

The  Collateral  Trust  Mortgage  in  Railway  Finance  (Quart.  Jour,  of 

Econ.,  vol.  xxi,  May,  1906,  pp.  443-467) 
Osborne,  E.  S. 

Short  Time  Loans  and  Sinking  Funds  (National  Association  of  Comp- 
trollers and  Accounting  Officers,  1914) 
Potter,  J. 

Debentures  (Accountant,  No.  1977,  vol.  xlvii.  Oct.  26, 1912,  pp.  526-531) 
Rahill,  J.  J. 

(In)  Corporation  Accounting  and  Law,  pp.  133-143  (Fresno  Republic 

Pub.  Co.,  Fresno,  Calif.,  1905) 
Ripley,  W.  Z. 

Collateral  Trust  Bonds   (Railway  Age  Gaz.,  vol.  xlii,  Jan.  12,  1912, 

pp.  48-49) 
Rollins,  Montgomery 

Convertible  Bonds  and  Stocks   (Annals  of  Amer.  Acad.  of  Pol.  and 

Soc.  Sci.,  vol.  xxxv,  No.  3,  May,  1910,  pp.  579-592) 

Convertible  Securities  (Boston,  The  Financial  Pub.  Co.,  1913,  pp.  271) 
Simonson,  Frederick  P. 

Debentures  and  Debenture  Stock  (Institute  of  Bankers  Jour.,  vol.  xix, 

pp.  249-264) 
Smythe,  Roland  Mulville 

Obsolete  American  Securities  and  Corporations   (New  York,  R.  M. 

Smythe,  2  vols.,  1904-1911) 

Building  and  Loan  Associations 

United  States  Bureau  of  Labor 

Ninth  Annual  Report,  Building  and  Loan  Associations  (Washington, 
D.  C.,  Gov.  Printing  Office,  pp.  710) 

Rosenthal,  H.  S. 

Building,  Loan  and  Savings  Associations,  How  to  Organize  and  Suc- 
cessfully Conduct  Them  (Cincinnati  and  Chicago,  Amer.  Bldg.  Assoc. 
News  Co.,  vol.  xv,  3rd,  pp.  425) 

United  States  Serial  No.  5639 

Loan  Companies,  Hearings  Before  Sub-Committee   (March  16,  1910, 


708  INVESTMENT  ANALYSIS 

61st  Cong.)  to  regulate  business  of  loaning  money  ou  security  of  any 
kind  by  persons,  firms  and  corporations  other  than  national  banks, 
savings  banks,  trust  companies,  and  real  estate  brokers  in  District, 
1911,  reprint  (District  of  Columbia  Committee,  Public  Document, 
May,  1911,  pp.  632) 

Capital  and  Capital  Stock 

Cleveland,  Frederick  Albert,  and  Powell,  Fred  Wilburn 

(In)  Railroad  Finance,  pp.  34-49  (New  York  and  London,  Appleton  & 

Co.,  1912) 
Conyngtou,  Thomas 

(In)   A  Manual  of  Corporate  Organization,  pp.  68-117    (New  York, 

The  Ronald  Press  Co.,  1917) 
Cole,  W.  M. 

(In)  Accounts,  Their  Construction  and  Interpretation,  pp.  69-78  and 

129-158  (Boston  and  New  York,  Houghton  Mifflin  Co.,  1908) 
Hatfield,  H.  R. 

(In)    Modern  Accounting,  pp.  144-183    (New  York,  Appleton  &  Co., 

1913) 
Lough,  William  H. 

(In)  Corporation  Finance,  pp.  284-296  (New  York,  Alexander  Ham- 
ilton Institute,  1913) 

(In)    Business   Finance,   pp.  200-228   and   355-379    (New  York,   The 

Ronald  Press  Co.,  1917) 
Masslich,  C.  B. 

Financing  A  New  Corporate  Enterprise  (Illinois  Law  Review,  vol.  v, 

No.  2,  June,  1910,  pp.  70-86) 
Meade,  Edward  Sherwood 

(In)  Corporation  Finance,  pp.  112-117;  328-331;  336-337,  and  338-341 

(New  York,  London,  Appleton  &  Co.,  1912) 
Rahill,  J.  H. 

(In)   Corporation  Accounting  and  Law,  pp.  172-189   (Fresno,  Calif., 

1906,  Pub.  by  Author) 
Whitten,  R.  H. 

(In)    Valuation  of  Public  Service  Corporation,  pp.  287-303    (Banks 

Law  Pub.  Co.,  1912) 

Capitalization 
Barker,  Samuel  H. 

Burdens  of  False  Capitalization  (Annals  of  Amer.  Acad=,  Pol.  and  Soc, 

Sci.,  vol.  xlviii,  No.  137,  July,  1913,  pp.  189-195) 
Bauer,  John 

The  Idea  of  Capitalization  As  Applied  to  Public  Service  Corporations 

(Jour,  of  Acct.,  vol.  xxii,  No.  1,  July,  1916,  pp.  1-9) 


APPENDIX  709 

Calkins,  G. 

The  Massachusetts  Anti-Stock  Watering  J..MW   (Quart.  Jour,  of  Econ., 

vol.  xxii,  No.  4,  1908,  pp.  640-645) 
Cleveland,  and  Powell 

(In)  Railroad  Finance,  pp.  34-149  (New  I'ork,  Appleton  &  Co.,  1912) 
Cole,  W.  M. 

(In)  Accounts  and  Their  Construction,  pp.  159-191  (Boston  and  New 

York,  Houghton  Mifflin  Co.,  190S) 
Cooper,  Francis 

(In)   Financing  an  Enterprise,  pp.  163-241   (New  York,  The  Ronald 

Press  Co.,  1909) 
Floy,  Henry 

(In)   Valuation  of  Public  Utilities,  pp.  129-167  (New  York,  McGraw 

Hill  Co.,  1912) 
Hatfield,  H.  R. 

(In)  Modern  Accounting,  pp.  70-120  (New  York,  Appletou  &  Co.,  1909) 
Heilman,  R.  E. 

The  Control  of  Interstate  Utility  Capitalization  by  State  Commissions 

(Jour,  of  Pol.  Econ.,  vol.  xxiv,  No.  5,  May,  1916,  pp.  474-489) 
Lough.  William  H. 

(In)    Business  Finance,  pp.  172-200  and  489-498    (New   York,  The 

Ronald  Press  Co.,  1917) 
Lyon,  Walter  Hastings 

(In)    Capitalization,  pp.  83-107    (Boston  and  New  York,  Houghton 

Mifflin  Co.,  1912) 

(In)    Capitalization,  pp.  1-82  and  108-143    (Boston  and  New  York, 

Houghton  Mifflin  Co.,  1912) 
Meade,  Edward  Sherwood 

(In)  Trust  Finance,  pp.  290-335  (New  York,  Appleton  &  Co.,  1909) 

(In)   Corporation  Finance,  pp.  385-405    (New  York,  Appleton  &  Co. 

1912) 
Montgomery,  Robert 

(In)    Auditing.  Theory  and  Practice,  pp.  104-134    (New  York,  The 

Ronald  Press  Co.,  1917) 
Ripley,  W.  Z. 

Stockwatering   (Pol.    Sci.    Quart,    vol.    xxvi,    No.    1,    March,    1911. 

pp.  99-121) 

Capitalization  of  Public  Service  Corporations  (Quart.  Jour,  of  Econ.. 

vol.  xv,  No.  1,  Nov.,  1900,  pp.  106-137) 
Royce,  E.  P. 

Capitalizing  Betterments  (Stone  and  Webster,  Pub.  Service,  vol.  xvii. 

Oct.,  1915,  pp.  235-238) 
Snyder,  Carl 

The  Real  Evil  Is  In  the  Railroad  Itself  (Jour,  of  Acct.,  vol.  iv,  No.  5, 

Sept.,  1907,  pp.  332-336) 


710  INVESTMENT  ANALYSIS 

Spencer,  A.  H. 

The  Prevention  of  Stockwatering  by  Public  Service  Corporations 
(Jour,  of  Pol.  Econ.,  vol.  xiv,  No.  9,  Nov.,  1906,  pp.  542-552) 

United  States  Industrial  Commission 

Basis  of  Capitalization  and  Nature  and  Methods  of  Stock  Watering, 
(In)  Final  Report  of  U.  S.  Indus.  Corum.  Kept,  vol.  xix,  1902, 
pp.  405-415. 

Classification  of  Bonds 
Cleveland,  F.  A. 

Classification  and  Description  of  Bonds   (Annals  of  Amer.  Acad.  of 

Pol.  and  Soc.  Sci.,  vol.  xxx,  No.  2,  Sept,  1C07,  pp.  400-411) 
Lownhaupt,  Frederick 

Classification  of  Bonds,  (In)  Investment  Bonds,  pp.  14-35  (New  York, 

Putman  &  Sons,  1908) 
Lyon,  William  H. 

Classification  of  Bonds,  (In)  Capitalization,  pp.  1-50  (New  York  and 

Boston,  Hough  ton  Mifflin  Co.,  1912) 

Classification  of  Investment  Bonds   (Annals  of  Amer.  Acad.  of  Pol. 

and  Soc.  Sci.,  vol.  Ixxxviii,  March,  1920,  pp.  4-12) 
Meade,  Edward  Sherwood 

Classification  and  Description  of  Bonds,   (In)   Corporation  Finance, 

pp.  306-337  (New  York  and  London,  Appleton  &  Co.,  1912) 
Squire,  Andreu 

Essential  Recitals  in  the  Various  Kinds  of  Bonds   (Annals  of  Amer. 

Acad.,  Pol.  and  Soc.  Sci.,  vol.  xxx,  No.  2,  Sept.,  1907,  pp.  248-256) 

Crises  and  Panics 

Annals  of  American  Academy  of  Political  and  Social  Science — Special 

Number  on  Panics 

(Annals  of  Amer.  Acad.  of  Pol.  and  Soc.  Sci.,  vol.  xxxi,  March,  1908, 

pp.  233) 
Andrew  A.  Pratt 

Hoarding  in  the  Panic  of  1907  (Quart.  Jour,  of  Econ.,  vol.  xxii,  Jan, 

1908,  No.  2,  pp.  290-300) 

Substitutes  for  Cash  in  the  Panic  of  1907   (Quart.  Jour,  of  Econ, 

vol.  xxii.,  No.  4,  Aug.,  1908,  pp.  497-517) 
Burton,  T.  E. 

Financial  Crisis  (New  York,  D.  Appleton  &  Co.,  1907,  pp.  392) 
England,  Minnie  T. 

An  Analysis  of  the  Crisis  Cycle  (Jour,  of  Pol.  Econ.,  vol.  xxl,  No.  8, 

Oct.,  1913,  pp.  712-735) 
Gardner,  J. 

The  Investment  Aspect  of  Financial  Stringency   (Fin.  Rev.  of  Rev., 

vol.  ix,  No.  99,  Jan.,  1914  pp.  18-27) 


APPENDIX  711 

Hull,  George  H. 

Industrial  Depressions,  Their  Cause  Analyzed  and  Classified  with  a 

Practical  Remedy  for  Such  as  Result  from  Industrial  Derangements 

(New  York,  Frederick  A.  Stokes  Co.,  1911,  pp.  287) 
Johnson,  J.  E. 

Crisis  and  Panic  of  1907    (Pol.   Sci.  Quart,  vol.  xxiii,   Sept.,  1906, 
pp.  454-67) 
Jones,  Edward  David 

Economic  Crises  and  Trade  Unions  (New  York,  Macmillan  Co.,  1900, 

pp.  251) 
Juglar,  Clement 

A  Brief  History  of  Panics  and  Their  Periodical  Occurrence,  Edited 

by  D.  C.  N.  Thomas,  1897   (New  York,  G.  P.  Putnam's  Sons,  1897, 

pp.  150) 
Lauck,  William  Jett 

Causes  of  the  Panic  of  1893  (New  York,  Houghton  Mifflin  Co.,  1907. 

pp.  122) 
Moore,  Henry  Ludwell 

Economic  Cycles:   Their  Law  and  Cause  (New  York,  The  Macmillan 

Co.,  1914,  pp.  149) 
Nicholson,  J.  S. 

Statistical  Aspects  of  Inflation  (Jour,  of  Royal  Stat.  Soc.,  vol.  Ixxx, 

Part  IV,  July,  1917,  pp.  1-21) 
Noyes,  Alexander  D. 

Financial  Panic  in  the  United  States  (Forum,  vol.  xxxix,  No.  3,  Jan., 

1908,  pp.  293-331) 
Sprague,  Oliver  Mitchell  Wentworth 

History  of  Crises  Under  the  National  Banking  System   (In  United 

States  National  Monetary  Commission  Series),  (U.  S.,  61  Cong.,  2nd 

Sess.,  Sen.  Doc.  538,  Wash.  Gov.  Ptg.  Office,  pp.  484) 

The  Crisis  of  1914  in  the  United  States   (Amer.  Econ.  Rev.,  vol.  F, 

No.  3,  Sept.,  1915,  pp.  499-534) 
Stevens,  Albert  C. 

Analysis  of  the  Phenomena  of  the  Panic  in  the  United  States  in  1891 

(Quart.  Jour,  of  Econ.,  vol.  xx,  Feb.,  1908,  No.  2,  pp.  65-87,  and  Apr., 

No.  4,  pp.  212-226) 
Swanson,  W.  W. 

The  Crisis  of  1860  and  the  First  Issue  of  Clearing  House  Certificates 

(Jour,  of  Pol.  Econ.,  vol.  xx,  No.  2,  Feb.,  1908,  pp.  65-87,  and  Apr., 

No.  4,  pp.  212-266) 
Wexler,  S. 

Lessons  of  the  Panics  of  1907  (Annals  Amer.  Acad.  of  Pol.  and  Soc. 

Sci.,  vol.  xxxi,  No.  2,  1908,  pp.  148-154) 


712  INVESTMENT  ANALYSIS 

Drainage  and  Levee  Bonds 

Chamberlain,  Lawrence 

(In)  The  Principles  of  Bond  Investments,  pp.  401-404  (New  York, 
Henry  Holt  Co.,  1911) 

Drainage  Laws 

Investments  Bankers'  Association,  1916 

Hecht,  R.  S. 

Louisiana  Municipal  Drainage  Bonds  (Proceedings  of  the  First 
Annual  Convention  of  the  Investment  Bankers'  Association,  1912, 
pp.  172-180) 

Palmer,  Benjamin  Whipple 

Swamp  Laud  Drainage  with  Special  Reference  to  Minnesota  (Univ. 
of  Min.,  1915,  pp.  138) 

Ross,  W.  G. 

Reclamation  of  Low  Lying  Lands  Along  the  Mississippi  (Stone  and 
Webster  Pub.  Service  Jour.,  vol.  xvi,  June,  1915,  pp.  431-435) 

Smith,  John 

Drainage  Bonds    (Proc.   of   the  Fourth  Annual   Convention  of   the 
Investment  Bankers'  Association,  1915,  pp.  120-130) 
Reclamation  of  Swamp  Lauds  and  the  Modern  Drainage  Bond  (Annals 
of  Amer.  Acad.  of  Pol.  &  Soc.  Sci.,  vol.  Ixxxviii,  No.  177,  Mar.,  1920, 
pp.  102-113) 

Electrical  Securities 

Adams,  Alton  D. 

Municipal  Electric  Plants  in  Massachusetts :    Testimony  Before  the 

United  States  Industrial  Commission  (Washington,  1901,  U.  S.  Indus. 

Cornm.  Reports,  vol.  ix,  pp.  275-285) 

Cost  of  Light  in  Municipal  and  Private  Gas  and  Electric  Light  Plants 

(Municipal  Engineering,  vol.  xxiii,  Sept.,  1902,  pp.  160-164) 
Gushing,  H.  C,  and  Harrison,  Newton 

Central  Station  Management   (New  York,  Van  Nostrand  Co.,  1916, 

pp. 397) 
Edwards,  H.  M. 

Electric  Light  Accounts  and  Their  Significance  (New  York,  McGraw- 
Hill  Book  Co.,  1914,  pp.  172) 
Floy,  Henry 

Depreciation  as  Related  to  Electrical  Properties    (Elec.  Ry.  Jour., 

vol.  xxxviii,  No.  1,  July  1,  1911) 

The  Colorado  Lighting  Controversy    (New  York,  The  Illuminating 

Eng.  Pub.  Co.,  1908,  pp.  327) 
Gibbings,  A.  H. 

Commercial  and  Business  Aspects  of  Municipal  Electricity  (Published 

by  the  author,  1899,  pp.  57) 


APPENDIX  713 

Insull,  Samuel 

Electrical  Securities  (Proc.  of  the  Second  Annual  Convention  of  the 
Investment  Bankers'  Assoc.  of  Arner.,  Oct.,  1913,  pp.  115-150) 
The  Progress  of  Economic  Power  Generation  and  Distribution  (Chi- 
cago, Pamphlet,  S.  Insull,  1916,  pp.  55) 

Centralization  of  Power  Supply  (Chicago,  Sherman  &  Co.,  1914, 
pp.  47) 

Johnson,  George 

Electric  Lighting  Accounts,  (In)  Accountants  Library  Series,  vol.  xxix 
(London,  Gee  &  Co.,  1914,  pp.  128) 

Lincoln,  Edmund  Earle 

The  Results  of  Municipal  Electric  Lighting  in  Massachusetts  (Boston 
and  New  York,  Houghton,  Mifflin  &  Co.,  1918,  pp.  485) 

Marks,  William  D. 

The  Finances  of  Gas  and  Electric  Light  and  Power  Industries  (New 
York,  1907,  pp.  540) 

Massachusetts  Board  of  Gas  and  Electric  Light  Commissioners :  Annual 
Reports,  1889  to  date 
(The  best  and  most  complete  state  reports  published) 

National  Electric  Light  Association 

Standard  Classification  of  Accounts  Compiled  by  the  Accounting  Sec- 
tion of  the  National  Electric  Light  Association  (New  York,  James 
Kempster  Printing  Co.,  1914,  pp.  117) 

Nash,  L.  R. 

New  Light  on  Diversity  Factors  (Stone  and  Webster  Pub.  Service 
Jour.,  vol.  xvii,  Aug.,  1915,  pp.  82-91) 

Demand  Electric  Rates  as  Affected  by  Commission  Regulation  (Stone 
and  Webster  Pub.  Service  Jour.,  vol.  xv,  Dec.,  1914,  pp.  432-437) 

National  Electric  Light  Association  Proceedings  (Annual,  since  1905) 

Patterson,  E.  M. 

A  Financial  History  of  the  Philadelphia  Electric  Company  (Phila- 
delphia, Director  of  Pub.  Works,  1914,  pp.  163) 

United  States  (House  Committee  on  the  District  of  Columbia) 

Fixing  the  Price  of  Gas  in  the  District  of  Columbia,  Report  of  Hear- 
ings of  January  31,  February  6  and  13,  1907 — H.  R.  (Wash.  Print'g. 
Office,  1917) 

United  States  Bureau  of  Census 

Special   Report   on   Electric   Light   and    Street   Railways   for   1907 

(Wash.  Gov.  Print'g.  Office) 

Electrical  Industries,  1902   (Special  Reports),   (Wash.  Gov.  Print'g. 

Office,  1906,  pp.  611) 

Central  Electric  Light  and  Power  Stations  and  Street  and  Electric 

Railways  with  Summary  of  the  Electrical  Industries  (Wash.  Print'g. 

Office,  1912,  pp.  912) 

(Bureau  of  the  Census,  1915,  pp.  440) 


714  INVESTMENT  ANALYSIS 

Watkins,  G.  P. 

Wisconsin,  Commission  on  Electric  Rates  (Quart.  Jour,  of  Econ.,  vol. 
xxvii,  No.  2  Feb.,  1913,  pp.  373-378) 

Equipment  Securities    (See  railroads) 

Financial  Institutions 

Anderson,  L.  A. 

Insurance  Investments  (Annals  of  Amer.  Acad.  of  Pol.  &  Soc.  Sci., 
vol.  xxiv,  No.  3,  Nov.,  1904,  pp.  1-16) 

Calkins,  Frederic  H. 

Compulsory  Investment  of  the  Funds  of  Life  Insurance  Companies : 
Why  Wrong  in  Principle  and  Hurtful  to  the  State  of  Florida  (Pre- 
sented at  Joint  Hearings  by  the  Senate  Committee  on  Corporations 
and  the  House  Committee  on  Insurance,  April  28,  1915,  pp.  30) 
(Pamphlet) 

Crozier,  J.  Beattie 

On  the  Natural  Value  of  Different  Stocks  :  Banks  and  Insurance  Com- 
pany, (In)  The  First  Principles  of  Investments,  pp.  10-33  (London, 
The  Finan.  Rev.  of  Rev.,  1910) 

Eckhardt,  H.  M.  P. 

Productivity  of  Capital  Invested  in  Banking  (Moody  Magazine, 
vol.  viii,  No.  1,  1909,  pp.  57-64) 

Edwards,  George  E. 

Interests  in  Common  of  Savings  Institutions  and  Life  Insurance  Com- 
panies (Assoc.  of  Life  Insurance  Presidents,  New  York.  Dec.  15. 
1916,  pp.  6)  (Pamphlet) 

Liquidity  of  Savings  Banks  Investments  (Jour,  of  Amer.  Bankers' 
Assoc.,  Sept.,  1915,  Fourth  Annual  Convention,  pp.  78-82) 

Equitable  Life  Insurance  Company 

Rates  Obtainable  in  Future  of  Investments  of  Life  Insurance  (Let- 
ters from  Prominent  Financiers  on  Interest  Rates,  1899,  pp.  61) 

Hamer,  J.  W. 

Life  Insurance  Investments  (Annals  of  Amer.  Acad.  of  Pol.  and  Soc. 
Sci.,  vol.  xvi,  No.  2,  Sept.,  1905,  pp.  76-88) 

Henry,  T.  M. 

Compulsory  Local  Investments  (Forty-fifth  National  Convention  of 
Insurance  Commissioners,  Sept.,  15,  1914,  pp.  21) 

Hogan,  John  V. 

Bond  Investments  by  National  Banks  (Jour,  of  Pol.  Econ.,  vol.  xxi, 
No.  9,  Nov.,  1913,  pp.  843-847) 

Lunger,  J.  B. 

Investment  of  Insurance  Funds,  (In)  Yale  Insurance  Lectures,  vol.  i. 
pp.  144-161  (New  Haven,  Tuttle  &  Moorehouse,  1903) 

Rollins,  Montgomery 

Laws  Regulating  the  Investment  of  Bank  Funds  (A  Compilation  of 


APPENDIX  715 

Laws  of  the  Various  States),    (Boston,  M.   Rollins,   Original  1905, 
Loose  Leaf) 
Zartman,  L.  W. 

Investments  of  Life  Insurance  Companies  (New  York,  Henry  Holt  & 
Co.,  1909,  pp.  257) 

Forms 

Cleveland,  Frederick  A. 

(In)   Funds  and  Their  Uses,  Part  III,  pp.  195-297   (New  York,  D. 

Appleton  Co.,  1916,  Revised  Edition) 
Conyngton,  Thomas 

Its  Methods,   Mechanism,   Formation,   and   Management,    (In)    The 

Modern   Corporation,   Part  IV,   chaps,   xvii-xxviii    (New  York,  The 

Ronald  Press,  1905) 
Lyon,  W.  H. 

(In)  Capitalization,  chaps,  i  and  vi  (New  York  and  Boston,  Houghton 

Mifflin  &  Co.,  1912) 
Wood,  W.  A. 

(In)  Modern  Business  Corporation,  Part  IX,  pp.  193-254  (The  Bobbs 

Merril  Co.,  Indianapolis,  1906) 

Franchises 
Arent,  L. 

Electric  Light  Franchises  in  New  York  City,    (In)    The  Columbia 

University  Studies  in  History,  Economics  and  Public  Law,  vol.  Ixxxviii, 

No.  201,  pp.  1S4  (New  York,  Longmans,  Green,  1919,  pp.  184) 
Carmen,  H.  J. 

The  Street  Surface  Railway  Franchises  of  New  York  City,  (In)  The 

Columbia  University  Studies  in  History,  Economics,  and  Public  Law, 

vol.  Ixxxviii,  No.  1  (New  York,  Longmans,  1919,  pp.  259) 
Coverdale,  W.  H. 

Railroad  Franchise  Values  in  Texas   (Railroad  Gazette,  vol.  xxxvi, 

No.  6,  Feb.  12,  1904,  pp.  115) 
Erickson,  Halford 

The  Indeterminate  Franchise  or  Permit  (Electrical  Review,  vol.  Ixv, 

No.  5,  Aug.  1,  1914,  pp.  224-227) 
James,  Edmund  J. 

Street  Railway  Franchises  In  the  City  of  Berlin  (Jour,  of  Pol.  Econ., 

vol.  ix,  No.  2,  March.  1901,  pp.  260-271) 
Joyce,  Joseph  Asbury 

A  Treatise  on  Franchises  (New  York,  The  Banking  Law  Pub.  Co., 

1909.  pp.  1130) 
King,  Clyde  Lyndon 

The  Regulation  of  Municipal  Utilities,  Edited  by  Clyde  Lyndon  King 
(New  York  and  London,  Appleton  &  Co.,  1912,  pp.  404) 


716  INVESTMENT  ANALYSIS 

Maltbie,  M.  R. 

Franchises   of   Electric  Corporations  in   Greater  New   York,   1911 ; 

Report  submitted  to  Public  Service  Commission  for  the  First  District, 

pp.  237  (Reprint  of  Appendix  A,  of  the  Annual  Report  of  the  Public 

Service  Commissions  of  the  1st  District,  1910) 
Seligman,  E.  R.  A. 

The  Franchise  Tax  Law  in  New  York  (Quart.  Jour,  of  Econ.,  vol.  xiii, 

No.  4,  July,  1899,  pp.  445-452) 
Tovey,  Philip 

(In)  Prospectuses,  pp.  66-93  (London,  G.  P.  Putnam's  Sons,  Ltd.,  1912) 
Wetterer,  C.  F.  W. 

The  Desirability  of  Indeterminate  Instead  of  Fixed-Term  Franchises 

(Stone  and  Webster  Pub.  Service  Jour.,  vol.  xviii,  Jan.,  1916,  pp.  19-23) 
Wilcox,  Delos  Franklin 

Municipal  Franchises  (New  York,  McGraw-Hill  Book  Co.,  1910,  two 

volumes) 
Wherry,  W.  M.,  Jr. 

Franchises  Values  (Electrical  R.  R.  Jour.,  vol.  xlii,  No.  158,  Oct.  15, 

1913,  pp.  781-782) 

Gas  Company  Bonds 

Accountants  Library 

Gas  Accounts,  Accountants  Library,  vol.  vii  (London,  Gee  &  Co.,  1902) 
Adams,  Alton  D. 

Municipal  Gas  and  Electric  Plants  in  Massachusetts  (Journal  of  Pol. 

Econ.,  vol.  x,  No.  2,  March,  1902,  pp.  214-230) 
Butterworth,  Wm.  C. 

The  Cost  and  Price  of  Gas  in  a  Small  City  (Amer.  Gas  Light  Jour., 

vol.  cii,  Mar.  22,  1915,  pp.  180-182) 
Bullard,  J.  E. 

Gas  Rates   (Amer.  Gas  Light  Jour.,  vol.  ci,  No.  22,  Nov.  30,  1914, 

pp.  337-339) 
Congress  of  Gas  Associations  of  America 

(St.  Louis,  June  15  and  16,  1904,  pp.  256) 
Chamberlain,  Lawrence 

(In)   The  Principles  of  Bond  Investments,  pp.  338-349   (New  York, 

Henry  Holt  Co.,  Fourth  Edition,  1911) 
Dawes,  Rufus  C. 

The  Modern  Gas  Company  as  Security  for  Bonds  (Proc.  of  the  Third 

Annual  Convention  of  the  Investment  Bankers'   Association,   1914, 

pp.  179-188) 
House  of  Committee  on  the  District  of  Columbia 

Report  of  Hearings  of  H.  J.   Rep.   82    (Hearings  held   March  25, 

April  8-13,  1908) 


APPENDIX  717 

Illinois  Bureau  of  Labor  Statistics 

History  of  the  Chicago  Gas  Companies,  Edited  by  W.  B.  Bemis  (Chi- 
cago Civic  Federation,  Chicago,  1897,  pp.  47) 

Lindsley,  Van  Sinderen 

Rate  Regulation  of  Gas  and  Electric  Lighting  (New  York,  The  Banks 
Law  Pub.  Co.,  1906,  pp.  164) 

Lewis,  W.  D. 

The  Lease  of  the  Philadelphia  Gas  Works  (Quart.  Jour,  of  Econ., 
vol.  xii,  Jan.,  1898,  pp.  209-24) 

Leeds,  Edward  P. 

Analysis  of  Gas  Corporation  Accounts  (Gas  Age,  vol.  xxxix,  Feb.  16, 
1917) 

Marks,  W.  D. 

Finances  of  Gas  and  Electric  Light  and  Power  Enterprises  (Third 
Edition,  Philadelphia,  W.  D.  Marks,  1907,  pp.  540) 

Munroe,  Charles  E. 

Cost  of  Gas  for  Baltimore;  Report  to  Robert  J.  McCuen,  Super- 
intendent of  Lamps  and  Lighting  of  the  City  of  Baltimore  (Baltimore, 

1911,  pp.  240) 
Nicholson,  J.  Shield 

Report,  Massachusetts  Committee  for  Investigation  of  Gas  Com- 
panies, 1893 

National  Commercial  Gas  Association  (Chairman,  F.  W.  Frulauff) 

Report  of  Committee  on  Differential  Rates  (Amer.  Gas  Light  Jour., 
vol.  cii,  Jan.  11,  1915,  pp.  18-23) 

Report  on  the  Boston  Sliding  Scale 

Report  of  the  Bd.  of  Gas  and  Electrical  Light  Commissioners  Relative 
to  the  Price  of  Gas  and  Rate  of  Dividends  as  Applied  to  the  Con- 
solidated Gas  Company,  and  known  as  the  London  Sliding  Scale 
(March,  1916,  pp.  57) 

Thornton,  W.  W. 

The  Law  Relating  to  Oil  and  Gas  (Cincinnati,  W.  H.  Anderson  &  Co., 

1912,  pp.  1184,  Second  Edition) 
The  Gas  World 

Analysis  of  Accounts  of  Gas  Undertakings,  1906-09  (London,  John 
Allan  &  Co.,  1908) 

Highway  Bonds   (See  Municipal  Bonds) 
Hydro-Electric  Securities  (See  Water  Power) 
Income  Tax  (See  Taxation  of  Securities) 

Industrial  Securities 
Conway  and  Atwood 

(In)  Investment  and  Speculation,  pp.  335-352   (Alexander  Hamilton 

Institute  Series,  1911) 


718  INVESTMENT  ANALYSIS 

Collver,  Clinton 

How  to  Analyze  Industrial  Securities  (New  York,  Moody 's  Investors 

Service,  1917,  pp.  204) 
Crozier,  J.  B. 

(In)  The  First  Principles  of  Investments,  pp.  33-50  (London,  Finan. 

Rev.,  1914) 
Dill,  J.  B. 

Industrials  as  Investments  for  Small  Capital  (Annals  of  Amer.  Acad. 

of  Pol.  and  Soc.  Sci.,  vol.  xv,  Supplement,  May,  1900,  pp.  107-119) 
Edwin,  E.  Eckel 

The  Portland  Cement  Industry  From  a  Financial  Standpoint    (New 

York,  Moody  Corpoiation,  1908,  pp.  93) 
Fairchild,  C.  S. 

The  Financiering  of  Trusts   (Amer.  Econ.  Rev.,  vol.  i,  No.  1,  Feb., 

1900,  Third  Series,  pp.  149-159) 
Gray,  J.  H. 

How  Does  Industrial  Valuation  Differ  From  Public  Utility  Valuation 

(New  York,  Amer.  Soc.  of  Mech.  Eng.,  1916,  pp.  36,  Pamphlet  Reprint) 
Henry,  George  G. 

Industrial  Bonds,  (In)  How  to  Invest  Money,  pp.  63-76  (New  York 

and  London,  Funk  &  Wagnalls  Co.,  1908) 
Jones,  J.  H. 

The  Tinplate  Industry  :   A  Study  in  Economic  Organization  (London, 

P.  S.  King  &  Son,  1914,  pp.  280) 
Judge,  A.  I.    (Editor) 

A  History  of  the  Canning  Industry  (Baltimore,  The  Canning  Trade, 

1914,  pp.  162) 
Lowenhaupt,  F. 

Industrial  Bonds  ( Moody 's  Magazine,  vol.  viii,  Sept.,  1909,  pp.  197-201) 
Lybrand,  Wm.  M. 

The  Accounting  of  Industrial  Enterprises   (Jour,  of  Acct.,  vol.  vii, 

No.  1,  Nov.,  1908,  pp.  32-40 ;  Dec.,  1908,  No.  2,  pp.  111-122 ;  Jan.,  1909, 

No.  3,  pp.  224-236) 
Macpherson.  F.  H. 

Corporation  Accounting  and  Investigations   (Jour,  of  Acct.,  vol.  vii, 

Nov.,  1908,  pp.  19-30) 
Meade,  Edward  Sherwood 

(In)  The  Careful  Investor,  pp.  232-43,  206-21  (Philadelphia  and  Lon- 
don, J.  B.  Lippincott  &  Co.,  1914) 
Meyer,  Edgar  J. 

Industrial  Stocks  as  Investment   (Annals  Amer.  Acad.  of  Pol.  and 

Soc.  Sci.,  vol.  xxxv,  No.  3,  May,  1910,  pp.  674-679) 
Moody,  John 

Industrial  Bonds    (Annals  Amer.  Acad.  of  Pol.  and   Soc.   Sci.,  vol. 

Ixxxviii,  176,  Feb.,  1920,  pp.  73-79) 


APPENDIX  719 

Noone,  John 

A  Study  of  Industrial  Corporation  Balance  Sheets  (Jour,  of  Acct., 

vol.  x,  No.  4,  Aug.,  1910,  pp.  241,  348  and  255-367) 
Raymond,  Wm.  L. 

Industrial   Bonds,    (In)    American  and   Foreign  Investment  Bonds, 

pp.  251-295  (Boston  and  New  York,  Houghton  Mifflin  &  Co.,  1916) 
Sakolski,  A.  M. 

The  Investment  Merits  of  Industrial  Securities  (Jour,  of  Acct.,  vol.  xii, 

No.  3,  July,  1911) 
Schmidt,  L.  W. 

Analysis  of  the  Industrial  Markets  (Moody's  Magazine,  vol.  xix,  No. 

12,  Dec.,  1916,  pp.  619-25) 
Sterrett,  J.  E. 

The  Comparative  Yield   on   Trade  and   Public   Service  Investment 

(Amer.  Econ.  Rev.,  vol.  vi,  No.  1,  March,  1916,  pp.  1-9) 

Insurance  Company  Investments  (See  Financial  Institutions) 

Interest  Rates 
Fisher,  Irving 

The  Rate  of  Interest:    Its  Nature,  Determination  and  Relation  to 

Economic  Phenomena  (New  York,  The  Macmillan  Co.,  1907,  pp.  422) 

The  Rate  of  Interest  After  the  War  (Annals  Ainer.  Acad.  of  Pol.  and 

Soc.  Sci.,  vol.  Ixviii,  Nov.,  1916,  pp.  244-252) 
Jones,  Edward  D. 

Industrial  Securities,   (In)  Investment,  xiv,  pp.  218-237  (New  York, 

Alexander  Hamilton  Institute  Series,  191S) 
Jordan,  David  F. 

Industrial  Securities,  (In)  Investments,  xii,  pp.  162-177  (New  York, 

Prentice-Hall  Co.,  1920) 
Krihben,  B.  D. 

Determination  of  Income  Rate  of  Investment  (Jour,  of  Acct.,  vol.  xv, 

May,  1913,  pp.  336-340) 
Mitchell,  Wesley  C: 

Interest  Rates  and  Prices  of  Investment  Securities   (Jour,  of  Pol. 

Econ.,  vol.  xix,  No.  4,  April,  1911,  pp.  2G9-30S) 

New  York  Money  Market,  Rates  from  1896-1906  (Jour,  of  Pol.  Econ., 

vol.  xxiv,  No.  2,  Feb.,  1916,  pp.  48  and  126-158) 
Scott,  Wm.  A. 

New  York  Money  Market,  Rates  from  1896-1906  (Jour,  of  Pol.  Econ., 

vol.  xvi.  No.  5.  May,  1908.  pp.  273-299) 
Sprague.  O.  M.  W. 

New  York  Money  Market   (Econ.  Jour.,  England,  vol.  xiii,  No.  49, 

March,  1903.  pp.  30-58) 


720  INVESTMENT  ANALYSIS 

Interurban  Securities 
Bogart,  Ernest  L. 

Interurban  Electric  Railway;  In  Ohio,  Economic  and  Social  Effects 

(Jour,  of  Pol.  Econ.,  vol.  xiv,  No.  10,  Dec.,  1906,  pp.  585-602) 
Conway,  Thomas,  Jr. 

The  Traffic  Problems  of  Interurban  Electric  Railroads  (Jour,  of  Acct, 

vol.  vi,  No.  5,  Sept.,  1908,  pp.  340-426,  and  vol.  vii,  No.  3,  Jan.,  1909, 

pp.  214-224) 
Doolittle,  F.  W. 

The  Present  and  Future  Development  of  Interurban  Railways  (Elec. 

Ry.  Jour.,  vol.  xlviii,  No.  10,  Sept.  2,  1916,  pp.  392-395) 
Fischer,  Louis  Engleman 

Economics  of  Interurban  Railways   (New  York,  McGraw-Hill  Book 

Co.,  1914,  pp.  116) 
Gonzenbach,  Ernest 

Engineering  Preliminaries  for  An  Interurban  Electric  Railway  (  New 

York,  McGraw  Pub.  Co.,  1903,  pp.  71) 
Gotshall,  W.  C. 

Notes  on  Electric  Railway  Economics  and  Preliminary  Engineering 

(New  York,  McGraw  Pub.  Co.,  1903,  pp.  251) 
Staub,  W.  A. 

The  Interrelation  of  Financial  and  Operating  Data  (Jour,  of  Acct., 

vol.  xvii,  No.  1,  Jan.,  1914,  pp.  1-12) 
VanDeusen,  Edgar 

Interurban  Bonds  as  an  Investment  Security  (Annals  of  Amer.  Acad. 

of  Pol.  &  Soc.  Sci.,  vol.  xxx,  No.  2,  Sept.  1907,  pp.  144-158) 

Irrigation  Securities 

Breu,  Morris 

The  Legal  Problems  of  Lands  by  Means  of  Irrigation    (Annals  of 

Amer.  Acad.  of  Pol.  and  Soc.  Sci.,  vol.  xxxiii,  pp.  664-676) 
Conway  and  Atwood 

(In)  Investment  and  Speculation,  pp.  328-333  (New  York,  Alexander 

Hamilton  Institute,  1911) 
Chamberlain,  Lawrence 

(In)   The  Principles  of  Bond  Investments,  pp.  384-400   (New  York, 

Henry  Holt  &  Co.,  1911) 
Ervin,  Guy 

Irrigation  Projects  Under  the  Provisions  of  the  Carey  Act    (U.  S., 

Dept.   of  Agric.   Circular,  124,   Wash.  D.   C.,   Feb.,   1919    [Pamphlet 

pp.  14] ) 
Fletcher,  R. 

United  States  Irrigation  Work  in  the  Northwest   (Eng.  News,  vol. 

Ixviii,  No.  20,  Nov.  14,  1912,  pp.  992-998) 


APPENDIX  721 

Henny,  D.  O. 

Federal  vs.  Private  Irrigation  (Eng.  News,  vol.  Ixxi,  No.  3,  Jan.  15, 

1914,  pp.  120-124) 
Hess,  Ralph  H. 

Beginnings  of  Irrigation  in  the  United  States  (Jour,  of  Pol.  Econ., 

vol.  xx,  No.  8,  Oct.,  1912,  pp.  807-834) 

Irrigation  Bonds  (Jour,  of  Acct.,  vol.  x,  No.  6,  Oct,  1910,  pp.  426-34) 
Investment  Bankers'  Association  Committee 

Report  of  Committee  on  Irrigation  Reclamation  and   Agricultural 

Credit.  Proc.  of  the  Third  Annual  Convention,  1914,  pp.  52-57) 
Lagerquist,  W.  E. 

Security  of  Irrigation  Bonds  (Moody  Magazine,  vol.  xi,  No.  3,  Aug., 

1911,  pp.  255-260) 
Long,  J.  R. 

A  Treatise  on  the  Law  of  Irrigation  Covering  All  States  and  Terri- 
tories (Second  Edition,  Denver,  Colo.,  W.  H.  Courtright  Pub.  Co., 

1916,  pp.  626) 
Newell,  F.  H. 

(In)  Principles  of  Irrigation  Engineering,  See  chaps,  i,  ii,  iii,  and  xix 

(New  York,  McGraw-Hill  Book  Company,  1913) 

Irrigation  of  the  United  States    (New  York,  T.  Y.  Crowell  &  Co., 

Rev.  Ed.,  1906,  pp.  417) 
Teele,  Ray  Palmer 

Government  Construction  of  Irrigation  Works   (Jour,  of  Pol.  Econ., 

vol.  x,  No.  3,  June,  1902,  pp.  394-409) 

The  Organization  of  Irrigation  Companies  (Jour,  of  Pol.  Econ.,  vol. 

viii,  No.  4,  March,  1904,  pp.  524-534  and  vol.  xii,  No.  2,  pp.  161-178) 

Irrigation  Relation  to  the  State  (Jour,  of  Pol.  Econ.,  vol.  xiv,  No.  4, 

Apr.,  1906,  pp.  236-252) 

Irrigation  in  the  United  States  (New  York,  Appleton,  1915,  pp.  252) 

Legal  Investments  of  Savings  Banks 

Crisculo,  L. 

A  Study  of  the  List  of  Legal  Investments  Issued  by  the  New  York 
State  Banking  Department  (Bankers'  Magz.,  vol.  xc,  No.  4,  April, 

1915,  pp.  447-451) 

Legal  Investments  in  New  York  State  (Bankers'  Magz.,  vol.  xci,  No.  1, 
July,  1915,  pp.  36-41) 

Hale,  Albert 

Savings  Bank  Investments  (Boston,  Mass.,  the  Author,  1908,  pp.  38) 

Mortimer,  F.  C. 

Investment  of  Trust  Funds  (New  York,  Bankers  Pub.  Co.,  1909) 

McKinney,  F.  C. 

Liabilities  of  Trustees  for  Investments :  General  Principles  ;  Statutes 
and  Decisions  of  Various  States  (New  York,  Trust  Companies  Maga- 
zine, 1914,  pp.  324) 


722  INVESTMENT  ANALYSTS 

White  &  Keinble 

List  of  Railroad  Bonds  Considered  Legal  Investments  for  Banks 
by  the  Banking  Departments  of  the  States  of  New  York,  Massa- 
chusetts, Connecticut,  Vermont  '(New  York,  White  &  Kemble,  1915, 
pp.  27) 

Legal  Treatises  on  Investments 

Abbott,  Howard  Strickland 

Public  Treatise  on  the  Law  of  Public  Securities  (Chicago,  Callaghan 

&  Co.,  1913,  pp.  1280) 
Dillon,  J.  F. 

Law  of  Municipal  Corporations  (Boston,  5th  Ed.,  Little,  Brown  Co., 

Five  Vols.,  1911) 
Dos  Passos,  J.  R. 

A  Treatise  of  the  Law  of  Stock  Brokers  and  Stock  Exchanges  (New 

York,  The  Banks  Law  Pub.  Co.,  1905,  Two  Vols.) 
Durfee,  E.  N.,  Editor 

Case  on  the  Law  of  Mortgages,  Selected  and  Annotated  (Indianapolis, 

Bobbs-Merrill  Co.,  1915,  pp.  531) 
Gross,  F.  L. 

The  Law  of  Real  Estate  Brokers  with  Forms  (New  York,  The  Ronald 

Press,  1910,  pp.  437) 
Hamilton,  C.  H. 

A  Treatise  on  the  Law  by  Special  Assessment  (New  York,  G.  I.  Jones, 

1907,  pp.  937) 
Harris,  W.  H. 

The  Laws  Governing  Issue  and  Transfer  of  Municipal  Bonds   (Cin- 
cinnati, W.  H.  Anderson  Co.,  1917,  pp.  359) 
Helliwell,  A.  L. 

A  Treatise  on  Stock  and  Stockholders  Covering  Watered  Stock,  Trusts, 

Consolidations  and  Holding  Companies  (St.  Paul,  Minn.,  Keefe-Daird- 

son  Co.,  1903,  pp.  1071) 
Ingersoll,  H.  R. 

Handbook  of  Law  of  Public  Corporations  (St.  Paul,  Minn.,  West  Pub. 

Co.,  1904,  pp.  738) 
Jones,  Leonard  Augustus 

A  Treatise  on  the  Law  of  Corporate  Bonds  and  Mortgages,  Pledges 

Including    Collateral    Securities     (Indianapolis,    Bobbs-Merrill    Co., 

1907,  pp.  849) 

A  Treatise  on  the  Law  of  Corporate  Bonds  and  Mortgages  (Indianap- 
olis, Bobbs-Merrill  Co.,  1907,  Ixxvi,  pp.  849) 
Lilly,  W. 

Individual  and  Corporation  Mortgages  (New  York,  Investment  Bank- 
ers' Association  of  America,  1918,  pp.  153) 


APPENDIX  723 

Lownhaupt,  Frederick 

(In)  Investment  Bonds,  pp.  6G-71  (New  York  and  London,  G.  P. 
Putman  &  Sons,  1908) 

Newhall,  G. 

The  Distribution  of  Estates  of  Deceased  Persons  in  Massachusetts 
(Boston,  G.  A.  Jackson,  1915) 

Rollins,  Montgomery 

Laws  Regulating  the  Investment  of  Bank  Funds  (Boston,  M.  Rollins, 
Loose  leaf,  frequently  revised,  pp.  184) 

Strawn,  Silas  H. 

Some  Covenants  Which  Every  Trust  Deed  Should  Contain  (Pro- 
ceedings of  the  Second  Annual  Convention  of  the  Investment  Bank- 
ers' Assoc.  of  America,  1913,  pp.  88-93) 

Stearns,  A.  A. 

The  Law  of  Suretyship,  Covering  Personal  Suretyship,  Commercial 
Guaranties,  Suretyship  as  Related  to  Bonds  to  Secure  Private  Obliga- 
tions, Official  and  Judicial  Bonds,  Surety  Companies  (Cincinnati, 
W.  H.  Anderson  Co.,  1915,  pp.  722) 

White,  F. 

Corporations :  Containing  the  Laws  as  Amended  to  January  1,  1915, 
Eighth  Edition  (New  York,  Baker,  Voorhis,  1915,  pp.  1858) 

Manuals  (Partial  List) 

Fitch,  J.  K. 

The  Fitch  Bond  Book,  Annual  (New  York,  Fitch  Publishing  Co.) 

Kimber,  A.  W. 

Kimber's  Railroad  Mortgage  Maps  (New  York,  A.  W.  Kimber  &  Co., 
1920,  First  Issue) 

Manual  of  Statistics 

Manual  of  Statistics :  Stock  Exchange  Hand  Book,  Annual  (New 
York,  Manual  of  Statistics  Co.) 

Martin,  J.  G.  (Compiler) 

Martin's  Boston  Stock  Market,  88  years  from  January,  1789,  to 
January,  1SS6,  comprising  the  annual  fluctuations  of  all  public  stocks 
and  investment  securities  .  .  .  with  the  semi-annual  dividends  paid 
by  each.  (Boston,  1886,  pp.  152) 

Moody's  Analysis  of  Investments 

Containing  in  Detailed  Form  a  Comparative  Analysis  of  Each  of  the 
Railroad  Systems,  Industrial  Corporations,  Public  Utilities  and  Gov- 
ernment, State  and  Municipal  Bonds  of  the  U.  S..  In  four  separate 
volumes  (New  York,  Annual,  since  1909  for  railroads,  Moody's 
Investors'  Service) 

Moody's  Manuals  of  Railroads,  Public  Utilities  and  Industrials  (In 
three  separate  volumes),  (New  York,  3900,  Annual,  Poor  Pub  Co.) 


724  INVESTMENT  ANALYSIS 

Mundy,  F.  W.  (Compiler) 

Mines  Handbook  (Annual)  (Tuckahoe,  N.  Y.,  W.  H.  Weed,  Pub- 
lisher, Annual) 

The  Earning  Power  of  Railroads :  Mileage,  Capitalization,  Bonded 
Indebtedness,  Earnings,  Operating  Expenses,  Cost  of  Maintenance, 
Fixed  Charges,  Comparative  Statistics,  etc.,  Annual  (New  York,  H. 
Oliphant  &  Co.) 

Poor's,  H.  V. 

Manuals  of  Public  Utilities,  Annual  (New  York,  Poor  Railroad  Man- 
ual Co.) 

Manual  of  the  Railroads  of  the  United  States,  Annual  (New  York, 
Poor's  Manual  R.  R.  Co.) 

Stevens,  H.  J. 

Copper  Handbook  (Published  Annually  until  1912,  New  York  City, 
The  Stevens  Copper  Handbook  Co.)  (Now  Called  Mines  Handbook.) 

The  Stock  Exchange  Official  Intelligence  (Annual) 

American  and  Foreign  Securities  of  Every  Nature  (Edited  by  the 
Secretary  of  the  Share  and  Loan  Dept.  of  the  London  Stock  Exchange) 

Smythe,  R.  M. 

Obsolete  American  Securities  and  Corporations  (New  York,  R.  M.- 
Smythe,  1904-1911) 

Standard  Statistics 

Status  of  Bonds  Under  the  Federal  Income  Tax,  Annual,  New  York, 

Standard  Statistics  Co.) 

Standard  Current  Card  Files  of  Corporations  (New  York,  currently 

revised) 

White  and  Kemble 

Atlas  and  Digest  of  Railroad  Mortgages;  a  Separate  Map  of  Each 
Important  System  (New  York,  White  &  Kemble) 

Market  of  Securities 
Andrew,  A.  P. 

Hoarding  in  the  Panic  (Quart.  Jour,  of  Econ.,  vol.  xxii,  No.  1,  Jan., 

1907,  pp.  290) 

The  Influence  of  Crops  Upon  Business  in  America   (Quart.  Jour,  of 

Econ.,  vol.  xx,  No.  3,  pp.  323-351) 
Annals  of  the  American  Academy  of  Pol.  &  Soc.  Science 

Stocks  and  the  Stock  Market    (The  Annals  of  the  Amer.  Acad.  of 

Pol.  &  Soc.  Sci.  [See  Table  of  Contents  for  Title],  vol.  xxxv,  No.  3, 

May,  1910,  pp.  236) 
Babson,  R.  W. 

Security  Prices  and  the  War  (Amer.  Econ.  Rev.,  vol.  viii,  No.  1,  March, 

1917,  pp.  5) 

Business  Barometers,  Annually   (Babson  Compiling  Office,  Wellesley 

Hills,  Mass.) 


APPENDIX  725 

Brookrnire,  J.  H. 

Methods  of  Business  Forecasting,  Based  on  Fundamental  Statistics 

(Amer.  Econ.  Rev.,  vol.  iii,  No.  1,  March,  1913,  pp.  43-59) 
Conant,  C.  A. 

How  the  Stock  Market  Reflects  Values   (N.  A.  Review,  vol.  clxxx, 

No.  3,  March,  1905,  pp.  347-359) 
Copeland,  Melvin  T.  (Edited  by) 

Business  Statistics    (Cambridge,  Mass.,  Harvard  University   Press, 

1917,  pp.  G96) 
Cox,  R.  L. 

Geographical  distribution  of  Life  Insurance  Investments  (New  York, 

Assn.  of  Life  Insurance  Presidents,  April  2,  1909,  pp.  13)   (Pamphlet) 
Crozier,  J.  B. 

(In)  The  First  Principles  of  Investments,  pp.  78-104  (London,  Finan- 
cial Rev.  of  Rev.,  1910) 
Davies,  A.  Emil 

The  Money  and  the  Stock  on  Share  Markets  (London,  Sir  I.  Pitman 

&  Sons,  Ltd.,  1909,  pp.  117) 
Duguid,  Charles 

How  to  Read  the  Money  Article,  Fifth  Edition  (London,  E.  Wilson, 

1911,  pp.  126) 
Giffen,  Robert 

British  Investments  Abroad   (Quart.  Rev.,  July,  1911,  vol.  ccxv,  No. 

428,  pp.  43-67) 
Grosvenor,  Wm.  M. 

American  Securities,  the  Causes  Influencing  Investment  and  Specula- 
tion, and  the  Fluctuations,  in  Values,  from  1872-1885    (New  York, 

Daily  Commercial  Bulletin,  1885,  pp.  270) 
Haney,  Lewis 

Marketing   and   Stock   Exchange,    (In)    Business   Organization   and 

Combination,  pp.  312-326  (New  York,  The  Macmillan  Co.,  1913) 
Harvard  University 

The  Review  of  Economic  Statistics,  current:    started  1919  (See  In- 

dex),    (Harvard  Univ.  Com.  on  Economic  Research,  Harvard  Univ. 

Press) 
Henry,  G.  G. 

Markets,    (In)   How  to  Invest  Money,  pp.  108-121    (New  York  and 

London,  Funk  &  Wagnalls  Co.,  1908) 
Hickernell,  Warren  F. 

Building  Business  Barometers  ( Moody 's  Magazine,  vol.  xviii,  No.  12, 

Dec.,  1915,  pp.  574-578) 
Hobson,  C.  K. 

The  Export  of  Capital :    Studies  in  Economic  and  Political  Science, 

No.  28:   London  School  of  Economics  (London,  Constable  &  Co.,  Ltd., 

1914,  pp.  264) 


726  INVESTMENT  ANALYSIS 

Huebener,  S.  S. 

The  Scope  and  Functions  of  the  Stock  Market  (Annals  of  Amer.  Acad., 
vol.  xxxv,  No.  3,  May,  1910,  pp.  483-505) 

Kemerer,  E.  W. 

Seasonal  Variations  in  Relative  Demand  for  Money  and  Capital  in 
United  States  (Sen.  Doc.  588,  61st  Cong.,  2nd  Sess.,  Pub.  Doc.,  Feb- 
ruary, 1911,  pp.  517) 

Lownhaupt,  Frederick 

The  Market,  (In)  Investment  Bonds,  pp.  73-90  (New  York,  G.  P. 
Putnam  &  Sons,  1908) 

Loree,  L.  F. 

Our  Borrowed  Capital  (New  York,  Annalist,  vol.  v,  No.  128,  June  28, 

1915,  pp.  674-675) 
Lyon,  W.  H. 

The  Market  and  the  Price,  (In)  Capitalization,  chap,  vii,  pp.  200-220 

(New  York,  Houghton  Mifflin  &  Co.,  1912) 
Magee,  James  Dysart 

Money  and  Prices,  A  Statistical  Study  of  Price  Movements  (Chicago, 

University  of  Chicago  Press,  1913,  pp.  89) 
Mead,  Edward  S. 

The   Investor   and   the   Gold    Supply,    (In)    The   Careful   Investor, 

pp.  261-267  (New  York,  Lippincott  &  Co.,  1914) 
Mitchell,  Wesley  C. 

Business    Cycles    (Berkley,    University    of    California    Press,    1913, 

pp.  610) 
Mulhall,  Michael 

British  Capital  Abroad   (North  Amer.  Rev.,  vol.  clxviii,  April.  1899, 

pp.  499-505) 
Norton,  J.  P. 

Statistical  Studies  in  the  New  York  Money  Market  (New  York,  Mac- 

millan  Company,  1903,  pp.  108) 
Noyes,  Alexander  Dana 

Forty  Years  of  American  Finance   (New  York  and  London,  G.  P. 

Putnam,  1909,  pp.  418) 
Pratt,  Edward  Ewing 

Foreign  Investments  (Proceedings  of  the  Fourth  Annual  Convention 

of  the  Investment  Bankers'  Association,  1915,  pp.  155-175) 
Pratt,  S.  S. 

The  Work  of  Wall  Street  (New  York,  Appleton  Co.,  1920,  pp.  440) 
Powell,  Ellis  T. 

The  Evolution  of  the  Money  Market  (London,  The  Financial  News, 

1916,  pp.  732) 
Selden,  C.  G. 

Psychology  of  the  Stock  Market  (New  York,  Tick,er  Publishing  Com- 
pany, 1912,  pp.  120) 


APPENDIX  727 

Trade  Cycles  and  the  Effort  to  Anticipate   (Quart.  Jour,  of  Econ. 

vol.  xvi,  No.  2,  Feb.,  1902,  pp.  293-310) 
Speare,  Charles  F. 

Foreign  Investments  of  the  Nations   (North  American,  July,  1909, 

vol.  cxc,  No.  1,  pp.  82-92. 
Sterns,  Worthy  P. 

Beginnings  of  American  Financial  Independence  (Jour,  of  Pol.  Econ., 

vol.  vi,  March,  1898,  pp.  187-208) 
United  States  Crop  Reporter 

Markets  and  Market  Conditions  (Published  by  United  States  Bureau 

of  Statistics) 
Wilson,  H. 

The   Relation   of   Government   to   Foreign   Investment    (Annals   of 

Amer.  Acad.  of  Pol.  and  Soc.  Sci.,  vol.  Ixviii,  No.  157,  Nov.,  1916, 

pp.  298-312) 
Withers,  Hartley 

Price  and  Securities,   (In)    Stock  and  Shares,  pp.  283-312   (London, 

1911,  Smith  Elder,  Second  Edition) 
Wyman,  Bruse 

Control  of  the  Market   (New  York,  Moffat  Yard  &  Company,  1911, 

pp.  282) 

Mathematics  of  Bond  Investments 

Bennett,  R.  J. 

Annuities  and  Bond  Discount  (Jour,  of  Acct.,  vol.  xix,  No.  6,  June, 
1915,  pp.  405-425) 

Brinkerhoff,  J.  J. 

The  Amortization  Plan  of  Valuing  Fixed  Term  Securities  (Thirty- 
ninth  Annual  Meeting.  National  Convention  of  Insurance  Commis- 
sioners, August  25,  1908,  pp.  7) 

Chamberlain,  Lawrence 

(In)  The  Principles  of  Bond  Investments,  pp.  405-554  (New  York, 
Henry  Holt  &  Co.,  1911) 

Chandler,  Alfred  D. 

Amortization  (Amer.  Econ.  Rev.,  vol.  iii,  No.  4,  Dec.,  1913.  pp.  875-893) 

Jordan.  David  F. 

Mathematics  of  Investment,  (In)  Investments,  chap.  xx.  pp.  265-247 
(New  York,  Prentice-Hall  &  Co.,  1920) 

Kelsey,  Otto 

In  Revaluation  of  Fixed  Term  Securities  (Thirty-ninth  Annual  Meet- 
ing, First  Convention  of  Insurance  Commissioners.  August  25,  1908, 
PP.  5) 

Kiffin.  William  H. 

Bond  Amortization  in  Theory  and  Practice  (Bankers'  Magazine, 
vol.  Ixxvii,  No.  1,  July,  1908.  pp.  28-351 


728  INVESTMENT  ANALYSIS 

Lyou,  VV.  11. 

Amortization,   (In)   Capitalization,  chap,  v,  pp.  144-165  (New  York, 

Houglitou  Mifflin  Co.,  1912) 
Massachusetts  Report  on  the   Proposed  Conversion  of   State   Sinking 

Fund  Bonds  by  Issue  of  Serial  Bonds  (Boston,  January,  1915,  House 

Doc.,  1650,  Submitted  by  the  Commission  on  Economy  and  Efficiency) 
Skinner,  Ernest  Brown 

The  Mathematical  Theory  of  Investments  (Boston  :  Ginn  &  Company, 

1913,  pp.  245) 
Sprague,  C.  B. 

Stock  Value  of  a  Bond   (Jour,  of  Acct.,  vol.  vi,  No.  3,  July,  1908, 

pp.  174-176) 

Accountancy  of  Investment  (New  York,  The  Eonald  Press  Co.,  1914, 

pp.  371) 

Mining  Securities 
American  Mining  Congress 

Proceedings  of  the  Congress  (Annual)    (First  Year,  1903) 
Arizona  Tax  Commission 

Special  Reports  on   State  Tax   Commission  of  Arizona  on   Mining 

Taxation,  Dated  March  17  and  20,  1913   (The  Arizona  State  Press, 

1913,  pp.  19) 
Bacon,  R.  F. 

The  American  Petroleum  Industry   (New  York,  McGraw-Hill,  1916, 

Three  Volumes) 
Bowen,  D. 

The  Taxation  of  Mines  in  Various  Countries,  (In)  Institute  of  Min- 
ing Engineers'  Transactions,  vol.  xliv) 
Chance,  H.  M. 

Coal  Mining  as  an  Investment  (Eng.  and  Min.  Magazine,  vol.  Ixxxviii, 

Aug.  14,  1909,  No.  7,  pp.  316-18) 
Channing,  J.  Parke 

Mine  Valuation  (Eng.  and  Min.  Jour.,  vol.  Ixxvi,  No.  11,  1913,  pp.  383) 
Conway  and  Atwood 

Mining  Stocks,   (In)   Investment  and  Speculation   (New  York,  Alex- 
ander Hamilton  Institute,  1911,  pp.  316-328) 
Findlay,  J.  R. 

Valuation  of  Iron  Mines  (Transactions,  Amer.  Inst.  of  Mining  Eng., 

vol.  xlv,  Oct.,  1913,  pp.  282-326) 
Finlay,  G.  R. 

The  Cost  of  Mining  (New  York,  McGraw-Hill  Co.,  1920,  pp.  500) 

Valuation  of  Iron  Mines  (Bui.  of  Amer.  Inst.  of  Min.  Eng.,  March, 

1913,  pp.  483) 
Hammond,  J.  H. 

Suggestions  Regarding  Mining  Investments,    (In)   E.  &  M.  H.,  vol. 

Ixxxix,  Jan.  to  Feb.,  1909,  pp.  2,  8,  157,  203,  204,  211,  352,  403,  449) 


APPENDIX  729 

Hoover,  H.  C 

Principles  of  Mining,  Valuations,  Organization  and  Administration, 

See  especially  pp.  1-57  and  181-185  (New  York,  McGraw-Hill  Pub.  Co., 

1909) 
McBeth,  Reid  S. 

Oil :   The  New  Monarch  of  Motion  (New  York,  Markets  Pub.  Corp., 

1919,  pp.  210) 
McGraw-Hill  Book  Company 

Mining  Library,  The  (Nine  Volumes),  (New  York,  McGraw-Hill  Book 

Co.,  1919) 
Nicholas,  Francis  C. 

Mining  Investments  and  How  to  Judge  Them   (New  York,  Moody's 

Magazine,  1909,  pp.  233) 
Pickering,  John  Clark 

Engineering  Analysis  of  a  Mining  Share  (New  York,  McGraw-Hill, 

1907,  pp.  95) 
Thompson,  J.  W. 

United  States  Mining  Statutes  Annotated  (Washington,  Dept.  of  the 

Interior,  Bureau  of  Mines,  1915,  pp.  860) 
Uglow,  W.  L. 

A  Study  of  Methods  of  Mine  Valuation  and  Assessment,  Methods  of 

Assessing  for  Taxation   (Madison,  Wisconsin,  Geology  and  Natural 

History  Survey,  1914,  pp.  67) 
Warwick,  A.  W. 

Capitalization  of  Small  Mines  (Eng.  and  Mining  Jour.,  vol.  xc,  No.  17, 

Oct.  15,  1910,  pp.  771-772) 

Mortgages 

Babson,  Roger  W. 

The  Rural  Credits  Act  and  Its  Effects  on  the  Investment  Market 
(Annals  of  Arner.  Acad.  of  Pol.  and  Soc.  Sriu,  vol.  Ixviii,  Nov.,  1916, 
pp.  235-244) 

Burton,  H.  J. 

Valuation  and  Depreciation  of  City  Buildings  (New  York,  National 
Assoc.  of  Building  Owners  and  Managers,  1919,  pp.  127) 

Clark,  Jesse  Redman 

Forty-six  Years'  Experience  with  Farm  Loans  (New  York  Assoc.  of 
Life  Insurance  Presidents,  Dec.  5  and  6,  1912,  pp.  10) 

Cox,  Robert  Lynn 

Life  Insurance  Investments  with  Special  Reference  to  Farm  Mort- 
gages (Ninth  Annual  Meeting  of  Association  of  Life  Insurance  Pres- 
idents, Dec.  9,  1915,  pp.  18) 

Hurd,  George  A. 

Real  Estate  Bonds  as  an  Investment  Security  (Annals  Amer.  Acad.  of 
Pol.  and  Soc.  Sci..  vol.  Ixxxviii.  March.  1920,  pp.  79-95  ) 


730  INVESTMENT  ANALYSIS 

Jones,  Edward  D. 

Farm  Mortgages,  (In)  Investment,  chap,  i,  pp.  1-9  (New  York,  Alex- 
ander Hamilton  Institute  Series,  1919) 

Urban  Real  Estate,    (In)   Investment,  chap,  xiii,  pp.  177-190   (New 

York,  Alexander  Hamilton  Institute  Series,  1919) 
Jordan,  David  F. 

Real  Estate  Mortgages,  (In)  Investments,  chap,  xiii,  pp.  177-190  (Ne<v 

York,  Prentice-Hall  &  Co.,  1920) 
Life  Insurance  Investments  and  Farm  Mortgages. 

Proceedings  of  the  Ninth  Annual  Meeting  of  the  Association  of  Li*e 

Insurance  Presidents,  1915,  pp.  146) 
Lutz,  H.  L. 

The  Somers   System  of  Realty  Valuation    (Quart.  Jour,  of  Econ., 

vol.  xxv,  No.  172,  pp.  172-181) 
Putnam,  George  E. 

The  Federal  Farm  Loan  System  (The  Amer.  Econ.  Rev.,  vol.  ix,  No.  3, 

March,  1919,  pp.  57-78) 
Robins,  K.  N. 

The  Farm  Mortgage  as  an  Investment   (New  York,  Scribner,  1919, 

pp.  240) 
Smith,  J.  Sheppard 

Reclamation  of  Swamp  Bonds  and  the  Modern  Drainage  Bond  (Amer. 

Acad.  of  Pol.  and  Soc.  Sci.,  vol.  Ixxxviii,  March,  1920,  pp.  102-114) 
Stoyle,  Richard  S. 

Farm  Loan  Bends  Under  the  Rural  Credits  Act  (Annals  Amer.  Acad. 

of  Pol.  and  Soc.  Sci.,  vol.  Ixxxviii,  March,  1920,  pp.  95-102) 
Wight,  Geo.  T. 

Life  Insurance  Farm  Loan  Investments  in  War  Time,  A  Report  Trans- 
mitted to  the  Life  Insurance  Companies  of  the  United  States,  August 

26,  1918,  pp.  13  (Assoc.  of  Life  Ins.  Presidents,  1918) 

Municipal  Bonds 
Adams,  Thomas  Sewell 

Increase  of  Public  Expenditure  and  Taxes  (Tenth  Annual  Meeting ; 

The  Association  of  Life  Insurance  Presidents,  New  York,  Dec.  15, 

1916,  pp.  12) 
Baker,  William  G. 

Report  of  Municipal  Securities  Committee  (Proceedings  of  the  Fifth 

Annual  Convention  of  the  Investment  Bankers'   Association,  1916, 

pp.  150-159) 
Beebe,  H.  F. 

Municipal  Credit  and   Its  New  Aspects   (Economic  World,  vol.  civ, 

Dec.  20, 1919) 
Bronson,  H.  A. 

Recitals  in  Municipal  Bonds  (Webb  Pub.  Co.,  St.  Paul,  1901,  pp.  230) 


APPENDIX  731 

Chamberlain,  Lawrence 

(In)    Principles  of  Bond  Investments,  County  Bonds,  pp.  159-179; 
City  and  Town  Bonds,  pp.  180-242;  The  Bonds  of  Tax  Districts, 
pp.  243-251  (New  York,  Henry  Holt  &  Co.,  1913) 
Repudiation  of  Atchinson,  Kansas   (Moody  Magazine,  August,  1913, 
vol.  xvi,  No.  2,  pp.  61) 
Chandler,  Alfred  D. 

The  Metropolitan  Debts  of  Boston  and  Vicinity   (Brookline,  Massa- 
chusetts, 1905,  pp.  78) 
Chapin,  A.  B. 

Municipal  Bonds   Over   the  Counter   and   in   Small   Denominations 
(Xat'l.  Municipal  Rev.,  vol.  v,  No.  4,  Oct.,  1916,  pp.  604-611) 
Clark,  F.  E. 

The  Purposes  of  the  Indebtedness  of  American  Cities,  1880-1912  (New 
York,  Municipal  Research  Bureau,  July,  1916,  pp.  73) 
Clow,  Frederick  R. 

City  Finances  (New  York,  The  Macmillan  Company,  1901,  pp.  148) 
Compton,  William  R. 

Municipal  Bonds  (Annals  Amer.  Acad.  of  Pol.  &  Soc.  Sci.  vol.  Ixxxviii, 
March,  1920,  pp.  51-57) 
Conway  and  Atwood 

Municipal    Bonds,    (In)    Investment    and    Speculation,    pp.    191-213 
(Alexander  Hamilton  Institute,  Modern  Business  Series,  1914) 
Dillon,  John  F. 

Commentaries  on  the  Law  of  Municipal  Corporations,  Five  Vohimes 
(Boston,  Little  Brown,  1911) 
Dean,  M.  B. 

Municipal  Bonds  Held  Void  (New  York,  B.  Dean,  1911,  pp.  122) 
Fisher,  Edmund  D. 

Municipal  Financing  (Proceedings  of  the  Second  Annual  Convention 
of   the    Investment   Bankers'    Association    of   America,    Oct.,    1913, 
pp.  57-76) 
Gephart,  W.  F. 

The  Demand  for  Capital  in  Relation  to  the  Interest  Rate  of  State 
and  Municipal  Bond  Issues  (Wash.  Univ.  Studies,  April,  1914,  pp.  20) 
Gettemy,  Charles  F. 

Indebtedness  of  the  Cities  and  Towns  of  a  Commonwealth   (Report 
of  the  Bureau  of  Statistics  of  Mass.,  1912,  pp.  3-35) 
The  New  Massachusetts  Legislation  Regulating  Municipal  Indebted- 
ness (National  Municipal  Rev.,  vol.  iii,  Oct.,  1914,  pp.  682-692) 
Hamilton,  C.  H. 

Law  of  Special  Assessments  (Chicago,  George  I.  Jones,  1907,  pp.  937) 
Hainer,  B.  T. 

Treatise  on  Modern  Law  of  Municipal  Securities  (Indianapolis,  Bobbs- 
Merrill.  1898) 


732  INVESTMENT  ANALYSIS 

Harris,  W.  H. 

Law  Governing  the  Issuing  Transfer  and  Collection  uf  Municipal 
Bonds  (Cincinnati,  Anderson  Co.,  Revised,  1917,  pp.  340) 

Hecht,  R.  S. 

Municipal  Finances  of  New  Orleans,  1860-1916  (New  Orleans, 
Hibernia  Bank  and  Trust  Co.,  1916,  pp.  32) 

Henry,  George  Garr 

Municipal  Bonds,  (In)  How  to  Invest  Money,  pp.  91-99  (New  York, 
Funk  &  Wagnalls  Co.,  1908) 

Hirst,  F.  W. 

Municipal  Finance  (Economic  Journal,  vol.  ix,  No.  35,  Sept.,  1899, 
pp.  384-393) 

Johnson,  A.  N. 

Highway  Laws  of  the  United  States  (New  York,  Municipal  Research, 
No.  82,  Feb.,  1917) 

Jordan,  David  F. 

Municipal  Bonds  Investments,  (In)  Investments,  chap,  vi,  pp.  01-71 
(New  York,  Prentice-Hall  &  Co.,  1920) 

Lewis,  N.  P. 

Highway  Indebtedness,  Its  Limitation  and  Regulation  (Pro.  Pan- 
Amer.  Road  Cong.,  1915,  pp.  122-127) 

Lownhaupt,  Frederick 

Municipal  Bonds,  (In)  Investment  Bonds,  pp.  215-224  (New  York, 
Putnam's  Sons,  1910) 

Massachusetts 

Annual  Reports  of  the  Statistics  of  Municipal  Finances  of  Massa- 
chusetts (Boston,  Bureau  of  Statistics) 

Municipal  Expenditures,  of  debt  and  assessed  valuation  and  showing 
the  volume  of  certification  of  notes  by  mouths  during  a  period  of  five 
years  (The  Eighth  Annual  Report  of  the  Statistics  of  Municipal 
Finances  of  Mass.,  Bureau  of  Statistics,  Boston,  1915,  pp.  301) 
Certification  of  Bonds  and  Notes  (Seventh  Annual  Report  of  Sta- 
tistics of  Municipal  Finances,  pp.  14-17) 

Report  of  the  Joint  Special  Committee  on  Municipal  Finance,  Jan- 
uary, 1913  (Boston,  1913,  House  Doc.,  1803,  pp.  103) 

Meade,  Edward  Sherwood 

Public  Obligations,  Municipal  Bonds  Preferred,  High  Yield  Municipal 
Bonds,  (In)  The  Careful  Investor,  pp.  93-114  (Philadelphia,  Lippiu- 
cott,  1914) 

Ohio  Legislative  Reference  Committee 

Report  on  the  Municipal  Finances  in  Ohio,  Report  of  the  Committee 
for  an  Investigation  of  Finances  of  Municipalities  (Bui.  of  the  Ohio 
Leg.  Ref.  Dept.,  Columbus,  February  3,  1915,  pp.  41,  F.  J.  Herr  Print- 
ing Co.) 


APPENDIX  733 

Pleydell,  A.  C. 

Municipal  Taxation  and  Extracts  on  Canadian  Systems  of  Local  Tax- 
ation (New  York,  New  York  Tax  Reform  Assoc.,  1909,  pp.  20) 
Prendergast,  Wm.  A. 

Financing  the  City  of  New  York,  Two  Lectures :   I.  How  the  City  Is 

Financed;  II.  The  City  Debt,  Delivered  at  New  York  Univ.,  March 

13  aod  28, 1916  (Pamphlet) 
Pierson,  A.  N. 

Analysis  of  the  Laws  Affecting  Municipal  and  County  Finances  and 

Taxation  (Trenton,  N.  J.,  Commission  for  the  Survey  of  Municipal 

Financing,  1918,  pp.  124) 
Plehn,  Carl  C. 

Government  Finance  in  the  United  States  (Chicago,  A.  C.  McClurg 

&  Co.,  1915,  pp.  166) 
Raymond,  Wm.  L. 

County,  Municipal  and  District  Bonds,   (In)   American  and  Foreign 

Investment  Bonds,  pp.  140-161    (Boston  and  New  York,  Hough  ton 

Mifflin  Co.,  1916) 
Reed,  Robert  R. 

Uniform  Municipal  Bond  Legislation  (Proceedings  of  the  First  Annual 

Convention  of  the  Investment  Bankers'  Assoc.,  1912,  pp.  92-102) 
Robinson,  Edward  Van  Dyke 

The  Cost  of  Government  in  Minnesota   (Amer.  Econ.  Rev.,  vol.  iii, 

No.  4,  Dec.,  1915,  pp.  815-831) 
Rollins,  Montgomery 

Municipal  and  Corporation  Bonds  (Boston,  D.  Estes  Co.,  1910,  pp.  186) 
Rosewater,  Victor 

Special  Assessments    (Columbia  University   Studies,  vol.   ii,   No.  3, 

1893,  pp.  152) 
Rudall,  J. 

American  Municipal  Bonds  as  Investments   (London :    Whittaker  & 

Company,  1874) 
Secrist,  H. 

An  Economic  Analysis  of  the  Constitutional  Restrictions  Upon  Public 

Indebtedness  in  the  United  States    (Bulletin  of  the  University  of 

Wisconsin,  No.  637,  Econ.  and  Pol.  Sci.  Series,  April,  1914) 
Smart,  William 

Municipal  Work  and  Finance  of  Glasgow  (Econ.  Jour.,  vol.  v,  No.  17, 

March,  1895,  pp.  35-49) 
Sonne,  H.  C. 

The  City,  Its  Finances  (London,  Wilson,  1915,  pp.  208) 
Sullivan,  Mark 

Present  States  of  Repudiated  State  Bonds   (The  North  Amer.  Rev., 

vol.  clxxix,  No.  6,  Dec.,  1904,  pp.  873-886) 


734  INVESTMENT  ANALYSIS 

Terrell,  Park 

Protection  of  the  Municipal  Bonds  (Annals  of  Amer.  Acad.  of  Pol. 
and  Soc.  Sci.,  vol.  xxx,  No.  2,  Sept.,  1907,  pp.  396-399) 

United  States  Bureau  of  Census 

County  and  Municipal  Indebtedness,  1890,  1913  and  1902,  and  Sinking 
Fund  Assets,  1913  (Wash.  Gov.  Printg.  Office,  1915,  pp.  228) 
Statistics  of  Cities  Having  a  Population  of  Over  30,000,  Special  Report 
Issued  in  1902,  1907,  1912,  1917   (Wash.  Gov.  Print'g  Office) 

Weil,  Harry  E. 

The  Physical  Condition  of  a  Municipality  Issuing  Bonds  (Annals  of 
Amer.  Acad.  of  Pol.  and  Soc.  Sci.,  vol.  xxx,  No.  2,  Sept.,  1907, 
pp.  384-389) 

Withers,  Hartley 

Government  and  Municipal  Securities,  (In)  Stocks  and  Shares, 
pp.  179-217  (Button  &  Co.,  1911,  Second  Edition) 

Works,  John  B. 

Special  Assessment  Bonds  (The  Proceedings  of  the  Fourth  Annual 
Convention  of  the  Investment  Bankers'  Association,  1915,  pp.  142-149) 

Wright,  J.  W. 

Municipal  Finance  (Accountant,  vol.  Ixvii,  No.  1979,  vol.  ix,  1912, 
pp.  590-600) 

National  Government  Bonds 
Adams,  Henry  C. 

International    Supervision   Over   Foreign   Investments    (The   Amer. 
Econ.  Rev.,  vol.  x,  No.  1,  Mar.,  1920,  pp.  58-67) 
Adams,  Henry  Carter 

Public  Credit,  (In)  The  Science  of  Finance,  pp.  518-560  (New  York, 
Henry  Holt  Co.,  1898) 

Public  Debts,  An  Essay  in  the  Science  of  Finance  (New  York,  Apple- 
ton  &  Co.,  1895,  pp.  407) 
American  Economic  Review  (The) 

Report  of  the  Committee  on  War  Finance  of  the  American  Economic 
Association,  Dec.,  1918  (Amer.  Econ.  Assoc.  Pub.) 
America's  Changing  Investment  Market 

(Annals  of  Amer.  Acad.  of  Pol.  and  Soc.  Sci.,  vol.  Ixviii,  Nov.,  1916, 
pp.  342) 
Anderson,  Gordon  Blythe 

The  Effect  of  the  War  on  New  Security  Issues  in  the  United  States 
(Amer.  Acad.  of  Pol.  and  Soc.  Sci.,  vol.  Ixviii,  Nov.,  1916,  pp.  118-131) 
Armitage-Smith,  George 

Public  Credit,  (In)  Principles  and  Methods  of  Taxation,  pp.  120-140 
(London,  J.  Murray,  1910) 
Bacon,  Nathaniel  F. 

American  International  Indebtedness  (Yale  Rev.,  vol.  xx,  No.  3,  1900, 
pp.  265-285) 


APPENDIX  735 

Babson,  Roger  Ward 

Japanese  Bonds  (Wellesley  Hills,  Mass.,  by  the  Author,  1907) 
Barter,  Dudley  R. 

National  Debts  (London,  Robert  John  Bush,  1871,  pp.  139) 
Bogart,  E.  L. 

Direct  and  Indirect  Costs  of  the  Great  World  War  (Carnegie  Endow- 
ment for  International  Peace;  Preliminary  Economic  Studies  of  the 

War,  vol.  xxiv,  1919,  pp.  334) 
Burn,  Joseph 

The   National   Debt,    (In)    Stock    Exchange   Investments    (London, 

Charles  and  Edwin  Lay  ton,  1909,  pp.  322) 
Chamberlain,  Lawrence 

United  States  Bonds,  (In)  The  Principles  of  Bond  Investments  (New 

York,  Henry  Holt  Co.,  1911,  pp.  115-121) 
Chase,  Harvey 

The  National  Budget  on  Its  Expenditure  Side  (Jour,  of  Acct.,  vol.  xv, 

No.  6,  June,  1913,  pp.  397) 

National   Finances    (Jour,    of   Acct,   vol.   xviii,   No.   4,    Oct.,   1914, 

pp.  277-292) 
Childs,  C.  Frederick 

United  States  Government  Bonds  (Annals  of  Amer.  Acad.  of  Pol.  and 

Soc.  Sci.,  vol.  Ixxxviii,  March,  1920,  pp.  43-51) 
Conway,  T.,  and  Atwood,  Albert 

Canadian  Bonds,  (In)  Investment  and  Speculation,  pp.  183-190  (New 

York,  Alexander  Hamilton  Institute  Series,  1914) 

Government  Bonds,    (In)    Investment  and   Speculation,   pp.  146-162 

(New  York,  Alexander  Hamilton  Institute  Series,  1914) 
Cook,  R.  G. 

Government  Bonds  (New  York,  R.  Cook,  1903,  Private  Ltd.) 
Coulter,  John  Lee 

National  and  State  Indebtedness  and  Funds  and  Investments,  1870- 

1913  (Prepared  Under  the  Supervision  of  J.  L.  Coulter,  Wash.  Gov. 

Printg.  Off.,  1914,  pp.  204) 
Denby,  C. 

The  National  Debt  of  China — Its  Origin  and  Its  Security   (Ann.  of 

Amer.  Acad.,  vol.  Ixviii,  Nov.,  1916,  pp.  55-71) 
Ferrin,  A.  W. 

Fall  in  Consols   (Moody's  Magazine,  vol.  xiv,  No.  2,  Aug.,  1912,  pp. 

89-91) 
Field,  Fred  W. 

Capital  Investments  in  Canada  (Toronto,  Canada,  Monetary  Times 
of  Canada,  1911,  pp.  240) 
Fisk,  H.  E. 

Our  Public  Debt  (New  York,  Bankers'  Trust  Co.,  1919,  pp.  126) 
English  Public  Finance,  from  the  Revolution  of  1688;  with  Chapters 
on  the  Bank  of  England  (New  York,  Bankers'  Trust  Co.,  1920,  pp.  241) 


736  INVESTMENT  ANALYSIS 

Fitch,  John  Knowles 

The  Fitch  Bond  Book  Describing  the  Most  Important  Bond  Issues  of 

the  United  States  and  Canada  (New  York,  The  Fitch  Publishing  Co., 

Annual) 
Fitch  Record  of  Government  Debts  (The) 

(New  York,  1917,  The  Fitch  Pub.  Co.,  pp.  374,  Issued  Annually) 
Gardner,  H.  B. 

Census  Report  on  Wealth,  Debt,  and  Taxation  (Amer.  Econ.  Rev., 

vol.  v,  No.  4,  Dec.,  1915,  pp.  932-42) 
Gibson,  A.  H. 

The  Price  of  Consols    (Bankers'  Magz.,  London,  vol.  xcv,  No.  826, 

Jan.,  1913,  pp.  10,  55-65) 

The  Fall  of  Consols  and  Other  Investments  from  1875-1897,  and  the 

Fall  Since  (London,  1908,  Simpkin,  Marshall  &  Co.,  pp.  93) 
Giffeu,  Sir  R. 

Consols  in  a  Great  War    (Econ.  Jour.,  vol.  ix,  No.  35,  Sept.,  1899, 

pp.  353-364) 
Cohn,  H. 

Depreciation   of   Government   Securities  in  Germany    (Econ.   Jour., 

vol.  xxii,  No.  88,  Dec.,  1912,  pp.  554-63) 
Gottlieb,  L.  R. 

Indebtedness  of  Principal  Belligerents   (Quart.  Jour,  of  Econ.,  vol. 

xxxiii,  May,  1919,  pp.  504-531) 

Debts,  Revenues  and  Expenditures,  and  Note  Circulation  of  the  Prin- 
cipal Belligerents  (Quart.  Jour.  Rev.  of  Econ.,  vol  xxxiii,  Nov.,  1919, 

pp.  161-205) 
Great  Britain 

National  Debt,  History  of  Funded  Debt  (Brit.  Parl.  Papers,  vol.  Ixiv, 

1898) 
Grice,  J.  Watson 

National  and  Local  Finance  (London,  P.  S.  King&  Son,  1910,  pp.  428) 
Guyot,  V. 

The  Amount,  Direction  and  Nature  of  French  Investments   (Annals 

of  Amer.  Acad.  of  Pol.  and  Soc.  Sci.,  vol.  Ixviii,  Nov.,  1916,  pp.  36-55) 
Haynes,  T. 

Variation   of    Value   of   Government   Securities    (Monthly    Consular 

Reports,  No.  295,  April  1,  1905,  pp.  257-278) 
Higgs,  H. 

A  Primer  of  National  Finance  (London :   Methuen,  1919,  pp.  168) 
Hobson,  C.  K. 

The  Export  of  Capital  (New  York,  The  Macmillan  Co.,  1914,  pp.  264) 

British  Oversea  Investments,  Their  Growth  and  Importance  (Annals 

of  Amer.  Acad.  of  Pol.  and  Soc.  Sci.,  vol.  Ixviii,  Nov.,  1916,  pp.  23-36) 
Hollander,  J.  H. 

The  Readjustment  of  San  Domingo's  Finances  (Quart.  Jour,  of  Econ., 

vol.  xxi,  No.  3,  May,  1907,  pp.  405-26) 


APPENDIX  737 

War  Borrowing,  A  Study  of  Treasury  Certificates  of  Indebtedness  of 

the  United  States  (New  York,  The  Macmillan  Co.,  1919.  pp.  215) 
Huebner,  S.  S. 

The  American  Security  Market  During  the  War   (Annals  of  Amer. 

Acad.  of  Pol.  and  Soc.  Sci.,  vol.  Ixviii,  Nov.,  1916,  pp.  93-108) 
Jordan,  David  F. 

Foreign  Investments,  (In)  Investments,  chap,  xiv,  pp.  190-201   (New 

York,  Prentice  Hall  &  Co.,  1920) 

United  States  Government  Bonds,  (In)  Investments,  chap,  iv,  pp.  31-42 

(New  York,  Prentice  Hall  &  Co.,  1920) 
Kemmerer,  Edwin  Walter 

The  Theory  of  Foreign  Investments  (The  Annals  of  Amer.  Acad.  of 

Pol.  and  Soc.  Sci.,  vol.  Ixviii,  Nov.,  1916,  pp.  1-10) 
Kerr,  E. 

The  Effects  of  War  and  Revolutions  on  Government  Securities  (Ex- 
ternal and  Internal),  (New  York  and  Chicago,  William  Morris  Imbrie 

&  Co.,  1917,  pp.  131) 
Kies,  W.  S. 

Latin- American  Securities  (Annals  of  Amer.  Acad.  of  Pol.  and  So'c. 

Sci.,  vol.  Ixxxviii,  Mar.,  1920,  pp.  144-156) 
Kimber,  Albert  W. 

Foreign  Government  Securities    (New  York,  A.  W.  Kimber  &  Co., 

1919,  pp.  302) 
King,  Willford  I. 

The  Wealth  and  Income  of  the  People  of  the  United  States    (New 

York,  Macmillan,  1915,  pp.  278) 
Lagerquist,  W.  E. 

Germany's  War  Finances    ( Moody 's  Magazine,  vol.  xix,  Nov.,  1916, 

pp.6) 
Lamont,  T.  W. 

Foreign  Government  Bonds  (Annals  of  Amer.  Acad.  of  Pol.  and  Soc. 

Sci.,  vol.  Ixxxviii,  Mar.,  1920,  pp.  121-130) 
Laughlin,  James 

Credit  of  the  Nations,  A  Study  of  the  European  War   (New  York, 

Scribners  Sons,  1918,  pp.  406) 
Learned,  Edward 

How  to  Pay  It,  or  a  Method  for  the  Discharging  of  the  National  Debt 

(Pamphlet,  New  York,  John  W.  Amerman,  1869,  pp.  19) 
Levy,  Fabian  F. 

Universal  Sinking  Fund  (New  York,  Compiled  and  Pub.  by  Fabian 

F.  Levy,  1917,  pp.  393) 
Lill,  T.  R. 

National  Debt  of  Mexico,  History  and  Present  States   (New  York, 

Searle,  Nicholson,  Oakley  &  Lill,  1919,  pp.  115) 


738  INVESTMENT  ANALYSIS 

Lowenfeld,  Henry 

Government     Bonds,      (In)      Investment     Practically     Considered, 

pp.  156-177  (London,  Financial  Rev.  of  Rev.,  1909) 
Lyon,  Hastings 

A  Gamble  in  Governments   (Moody  Magazine,  vol.  xi,  No.  3,  Mar., 

1911,  pp.  181-186) 
Macpherson,  G.  A. 

Canadian  Bonds   (Amer.  Acad.  of  Pol.  and  Soc.  ScL,  vol.  Ixxxviii, 

Mar.,  1920,  pp.  139-144) 
National  Bank  of  Commerce 

War  Finance  Primer  (New  York,  National  Bank  of  Commerce,  1917, 

pp.  135) 
Noyes,  Alexander  D. 

Forty  Years  of  American  Finance  (New  York,  G.  P.  Putnam's  Sons, 

1909,  pp.  418) 
Paish,  George 

Great  Britain  Capital  Investments  in  Other  Lands   (Roy.  Stat.  Soc. 

Jour.,  vol.  Ixxii,  Sept.,  1909,  Part  III,  pp.  465-480) 
Plehn,  Carl  Copping 

Public  Indebtedness,   (In  Introduction  to  Public  Finance,  Part  III, 

New  York,  The  Macmillan  Co.,  1920) 

Government  Finance  in  the  United  States  (The  Nat.  Sci.  Series,  Edited 

by  Imbrie  &  Company,  Frank  L.  McVey,  Chicago,   A.   C.  McClurg 

&  Co.,  1915,  pp.  166) 

Prices  of  Brazilian  Government  Bonds  During  the  Last  Fifty  Years 

(New  York,  Imbrie  &  Co.,  1919) 
Raymond,  Wm.  Lee 

Government  Bonds,   (In)   American  and  Foreign  Investment  Bonds, 

pp.  5-93  (Boston  and  New  York,  Houghton  Mifflin  Co.,  1916) 
Report  of  the  Committee  on  War  Finance  of  the  American  Economic 

Association  (The  Amer.  Econ.  Rev.  vol,  ix,  Supplement  No.  2,  March, 

1919) 
Richardson,  W.  A.  (Sec.  of  Treas.) 

Practical  Information   Concerning  the  Public  Debt   of  the  United 

States  with  the  National  Banking  Laws    (Third  Edition),    (Wash- 
ington. D.  C.,  W.  H.  and  O.  H.  Morrison,  1872,  pp.  190) 
Rosenthal,  Arthur  J. 

Foreign  Corporate  Bonds  in  the  American  Market  (Annals  of  Amer. 

Acad.  of  Pol.  and  Soc.  Sci.,  vol.  Ixxxviii,  March,  1920,  pp.  130-139) 
Roussin,  L.  G. 

Some  Aspects  of  War  Finance  (Econ.  Jour.,  vol.  xxix,  Mar.,  1919, 

pp.  37-48) 
Sargant,  Wm.  Lucas 

Apology   for   Sinking  Funds    (London,   Williams  &  Norgate,   1868, 

pp.  247) 


APPENDIX  739 

Schwabe,  Walter  S.  (Assisted  by  Philips  Guedallia) 

The  Effect  of  War  on  Stock  Exchange  Transactions  (London,  Effing- 
ham  Wilson,  1915,  pp.  134) 

Selwyn-Brown,  A. 

The  Decline  in  British  Consols  (Moody  Magazine,  vol.  x,  No.  4,  Oct., 
1910,  pp.  256-260) 

Shelden,  James 

The  Need  for  American  Investment  in  Foreign  Securities  (Annals  of 
Amer.  Acad.  of  Pol.  and  Soc.  Sci.,  vol.  Ixxxviii,  Mar.,  1920,  pp.  114-121) 

Skelton,  O.  D. 

Canadian  War  Finance  (Amer.  Econ.  Rev.,  vol.  vii,  No.  4,  Dec.,  1917, 
pp.  816-831) 

Taussig,  F.  W. 

Germany's  Reparation  Payments  (Amer.  Econ.  Review,  vol.  x,  No.  1, 
Mar.,  1920,  pp.  33-49) 

United  States  Bureau  of  Statistics 

National  Debts  of  the  World  (Wash.  Govern.  Printg.  Office,  1901,  In 
the  Summary  of  Commerce  and  Finance  for  March,  1901,  pp.  2141- 
2221) 

United  States  National  Monetary  Commission  (By  Hirst,  Francis  W.) 
The  Credit  of  Nations    (61st  Cong.,  2nd  Sess.,  Doctrine,  No.  579), 
(Wash.  Gov.  Printg.  Office,  1910,  pp.  213) 

United  States  Treasury  Department 

Treasury  Information  Respecting  United  States  Bonds;  Paper  Cur- 
rency and  Coin,  Production  of  Precious  Metals,  etc.,  Revised,  July  1, 
1915  (Wash.  Gov.  Printg.  Office,  1915,  pp.  106,  Previous  editions  pub- 
lished in  1908,  1897) 

List  of  United  States  Bonds,  Loans  and  Currency  Division  (Issued 
Monthly) 

United  States  Information  Respecting  United  States  Bonds,  Paper  Cur- 
rency, Coin,  Production  of  Precious  Metals,  etc.  (Treas.  Depart, 
Current  Circular) 

United  States 

Investigation  of  Sale  of  Bonds  During  Years  1894,  1895  and  1896 
(54th  Congress,  2nd  Session  Senate  Doc.,  187;  bound  in  Volume  5 
with  other  doctrines,  serial  No.  3471,  pp.  332) 

Toungman,  Elmer  H. 

Short  Term  Investments  as  a  Stabilizing  Influence  in  International 
Finance  (Annals  Amer.  Acad.  of  Pol.  and  Soc.  Sci.,  vol.  Ixviii,  Nov., 
1916,  pp.  108-118) 

United  States  Bureau  of  the  Census 

Wealth,  Debt  and  Taxation,  National  and  States  Indebtedness,  Assets 
of  Productive  Funds  and  Investments.  1870-1913,  pp.  208-211;  Tax- 
ation and  Revenue  Systems  of  State  and  Local  Governments, 
pp.  449-715  Washington,  Bureau  of  the  Census.  1914)  (Supplements 
are  issued  at  intervals."* 


740  INVESTMENT  ANALYSIS 

Winston,  A.  P. 

Chinese  Finance  Under  the  Republic  (Quart.  Jour,  of  Econ.,  vol.  xxx, 

No.  4,  Aug.,  1916,  pp.  738-780) 
Withers,  Hartley 

International  Finance  (New  York,  Dutton  &  Co.,  1916,  pp.  186) 

War  and  Lombard  Street  (London,  Smith  Elder  &  Co.,  1916,  pp.  171) 
Withers,  Hartley 

Our  Money  and  the  State  (London,  J.  Murray,  1917,  pp.  122) 
Young,  E.  Hilton 

The  System  of  National  Finance  (London,  Smith  Elder  &  Co.,  1915, 

pp.  364) 

Notes  (Short-term)  See  Bonds 

Price  of  Securities 
Bond,  Frederick  Drew 

Stocks,  Prices,  Factors  in  Their  Rise  and  Fall  (New  York,  Moody's 

Magazine,  Book  Dept.,  1911,  pp.  124) 
Chamberlain,  Lawrence 

Prices   of    Securities,    (In)    The   Principles    of    Bond    Investments, 

pp.  455-512  (New  York,  Henry  Holt,  1911) 
Economic  Journal  (London) 

Depreciation  of  British  Home  Investments,  by  a  "Stockbroker"  (Econ. 

Jour.,  vol.  xxii,  No.  86,  June,  1912,  pp.  218-231) 
Ellis,  Arthur 

The  Quantitation  of  Stock  Exchange  Values   (Royal  Jour,  of  Stat 

Soc.,  vol.  li,  Sept.,  1888,  pp.  567-589) 
Gibson,  Thomas 

Influences  Affecting  Security  Prices  and  Values   (Annals  of  Amer. 

Acad.,  vol.  xxxv,  No.  3,  May,  1910,  pp.  145-54) 
Harvard  Bureau  of  Research 

The  Review  of  Economics  and  Statistics  (Harvard  Univ.  Committee 

on  Econ.  Research,  1919,  Preliminary) 
Magee,  James  Dysart 

Money  and  Prices  (Jour,  of  Pol.  Econ.,  vol.  xxi,  Part  I,  No.  8,  Oct., 

1913,  pp.  681-712 ;  vol.  xxi,  Part  II,  No.  9,  Nov.,  1913,  pp.  798-819) 
Mitchell,  Wesley  C. 

American  Security  Prices  and  Interest  Rates   (Jour,  of  Pol.  Econ., 

vol.  xxiv,  May,  1916,  pp.  126-157) 

The  Prices  of  American  Stocks,  1890-1909  (Jour,  of  Pol.  Econ.,  vol. 

xviii,  No.  7,  July.  1910,  pp.  513-525) 

The  Dun-Gibson  Index  Number  (Quart.  Jour,  of  Econ.,  vol.  xxv,  No.  1, 

Nov.,  1910,  pp.  161-172) 
Norton,  J.  P. 

A  Revised  Index  Number  for  Measuring  the  Rise  in  Prices   (Quart. 

Jour,  of  Econ.,  vol.  xxiv,  No.  4,  Aug.,  1910,  pp.  750-759) 


APPENDIX  741 

Statistical  Studies  in  New  York  Money  Market   (New  York,  Mao- 

millan  Co.,  1902,  pp.  108) 
Persons,  Warren  M. 

An  Index  of  Business  Conditions  (The  Harvard  Review  of  Economic 

Statistics,  vol.  i,  1919,  pp.  111-205) 

Construction  of  Business  Barometers  (Amer.  Econ.  Rev.,  vol.  iii,  1916, 

pp.  1-59) 
Selwyn-Brown,  A, 

Economic  Crises  and  Stock  Security  Values  (Annals  of  Amer.  Acad., 

vol.  xxxv,  No.  3,  May,  1910,  pp.  154-164) 
Sumner,  G.  Lynn  (Ed.) 

How  to  Invest  When  Prices  Are  Rising  (Scranton,  Pa.,  1912,  G.  L. 

Sumner  &  Co.,  pp.  114) 
United  States  National  Monetary  Commission,   (By)  Kemmerer,  Edwin 

Walter 

Seasonal  Variations  in  the  Relative  Demand  for  Money  and  Capital 

in  the  United   States  61st  Congress  2nd  Sess.,   Sen.  Doc.,  No.  588 

(Washington,  Gov.  Printg.  Office,  1910,  pp.  517) 

Public  Utility  Securities 
Adams,  Alton  D. 

Municipal,  Gas  and  Electric  Plants  in  Massachusetts   (Jour,  of  Pol. 

Econ.,  vol.  x.,  No.  10,  Mar.,  1902,  pp.  214-229) 
Addinsell,  H.  M. 

Public  Service  Bonds  (Annals  of  Amer.  Acad.  of  Pol.  and  Soc.  Sci., 

vol.  Ixxxviii,  Mar.,  1920,  pp.  63-73) 
Arnold,  Bion  J. 

The  Traffic  of  the  Subway  of  the  Interborough  Rapid  Transit  Com- 
pany of  New  York  City  (Submitted  to  Public  Service  Commission  of 

the  First  District  of  New  York,  1909,  pp.  69) 
Baltimore  Electrical  Commission 

Report  of  the  Electrical  Commission  to  the  Mayor  and  City  Council 

(Baltimore,  1896,  pp.  197) 
Barker,  Harry 

Public   Utility    Rates    (New    York,    McGraw-Hill    Book    Co.,    1917, 

pp.  387) 
Bauer,  J. 

Returns  on  Public  Service  Properties  (Pol.  Sci.  Quart.,  vol.  xxx,  No.  1, 

Mar.,  1915,  pp.  106-33) 

Valuation  of  Public  Service  Properties   (Pol.  Sci.  Quart.,  voL  xxx, 

No.  2,  June,  1915,  pp.  254-277) 
Chamberlain,  Lawrence 

Logic  of  Public  Service  Bonds  ( Moody 's  Magazine,  vol.  xv,  No.  5,  May, 

1916,  pp.  371-376) 


742  INVESTMENT  ANALYSIS 

Comvay  and  Atwood 

Public  Utility  Bonds,   (In)  Investment  and  Speculation,  pp.  270-289 
(New  York,  Alexander  Hamilton  Institute  Series,  1914) 
Cooke,  A. 

Financing  of  Public  Utility  Properties  (Gas  Age,  vol.  xxxvi,  No.  2, 

July  15,  1915,  pp.  57-59) 
Dewing,  Arthur  S. 

Public   Service   Corporation    Securities ;    Lecture   Boston    School    of 

Commerce  and  Finance,  1913  (Boston,  Marshal  &  Co.,  1915,  pp.  27) 
Eastman,  J.  B. 

Public  Service  Commission  of  Massachusetts  (Quart.  Jour,  of  Econ., 

vol.  xxvii,  No.  4,  Aug.,  1913,  pp.  609-707) 
Frame,  Andrew  J. 

An  Equitable  Solution  of  the  Public  Utility  and  Conservation  Prob- 
lems  (Proc.  of  the  Third  Annual  Convention  Investment  Bankers' 

Assoc.,  1914,  pp.  133-144) 
Hayes,  Hammond  V. 

Public  Utilities ;   Their  Construction  New  and   Depreciation    (New 

York,  Van  Nostrand  Co.,  1913,  pp.  262) 

Public  Utilities;  Their  Fair  Present  Values  and  Return  (New  York, 

Van  Nostrand  Co.,  1915,  pp.  203) 
Heilman,  R.  E. 

The  Development  by  Commissions  of  the  Principles  of  Public  Utility 

Capitalization  (Jour,  of  Pol.  Econ.,  vol.  xxiii,  Nov.,  1915,  pp.  888-910) 

Chicago  Traction    (Amer.  Econ.  Assoc.  Publications,  vol.  ix,   June, 

1908.  pp.  131) 
Henry,  George  Garr 

Public  Utility  Bonds,    (In)   How  to  Invest  Money,  pp.  76-90   (New 

York,  Funk  &  Wagnalls,  1908) 
Ignatius,  Milton  B. 

The  Financing  of   a   Public   Service  Corporation    (New   York,   The 

Ronald  Press,  1918,  pp.  508) 
Investment  Bankers'  Association  Committee 

Report  of  the  Committee  on  Public  Service  Corporations    (Proc.  of 

Fourth  Annual  Convention  of  the  Investment  Bankers'  Assoc.,  1015, 

pp.  77-83) 
Jordan,  David  F. 

Public  Utility   Securities,    (In)    Investments,   chap,   xi,   pp.   124-162 

(New  York,  Prentice-Hall  &  Co.,  1920) 
Kramer,  A.  L. 

Securities  of  Public  Service  Corporations  as  Investments  (Annals  of 

Amer.   Acad.   of   Pol.    and   Soc.    Sci.,   vol.    xxv,    No.    1,    Jan.,   1905, 

pp.  101-117) 
Lawyers  Co-operative  Publishing  Company 

Public  Utilities  Reports   (Annotated),  Containing:    Decisions  of  the 


APPENDIX  743 

Public  Service  Commissions, .  Annual  from   1915    (Usually  8   to  10 

volumes  per   year),    Rochester,   X.   Y.,   The   Lawyers    Co-operative 

Pub.  Co.) 
Lincoln,  E.  E. 

The  Control  of  Return  on  Public  Utility  Investments   (Amer.  Econ. 

Rev.,  vol.  vi,  No.  4,  Dec,  1916,  pp.  869-874) 

Municipal  Lighting  in  Massachusetts   (Harvard  University  Studies, 

Cambridge  Press,  1920,  pp.  484) 
Mead,  Edward  Sherwood 

Public  Utility   Securities,    (In)    The   Careful   Investor,  pp.   134-184 

(Philadelphia,  Lippincott  &  Co.,  1914) 
National  Civic  Federation  Regulation  of  Public  Utilities 

A  Compilation  and  an  Analysis  of  the  Laws  of  Forty-three  States 

(New  York,  The  National  Civic  Federation,  1913,  pp.  1284) 
Nicholson,  J.  Shields 

Report  of  Massachusetts  Committee  for  Investigation  of  Gas  Com- 
panies, 1893,  pp.  578) 
Oldham,  John  E. 

Public  Utility  Bonds  (Proc.  of  the  Second  Annual  Convention  of  the 

Investment  Bankers'  Assoc.,  1913,  pp.  196-205) 

Report  of  Committee  on  Public  Service  Securities  (Proc.  of  the  Fifth 

Annual    Convention     of    the    Investment    Bankers'     Assoc.,     1916; 

pp.  105-116) 
Parmelee,  J.  H. 

Public  Service  Statistics  in  the  United  States  (Amer.  Statis.  Assoc.. 

June,  1915,  pp.  489-504) 
Raymond,  Wm.  L. 

Public  Utility   Securities,    (In)    American   and   Foreign   Investment 

Bonds,  pp.  198-250    (Boston  and  New   York,  Houghton  Mifflin   Co., 

1915) 
State  Reports 

Annual  Reports  and  Decisions  of  a  Number  of  the  State  Public  Utility 

Commissions,  Furnish  Some  of  the  Most   Valuable  Information  on 

the  Subject  of  Public  Utilities.    Those  of  New  York,  Massachusetts, 

Wisconsin,  California  are  especially  valuable. 
Sterrett,  J.  E. 

The   Comparative  Yield   on  Trade  and   Public   Service   Investment 

(Amer.  Econ.  Rev.,  vol.  vi,  No.  1,  Mar.,  1916,  pp.  1-9) 
Wilcox,  Delas  F. 

The  Future  of  Public  Utility  Investments  (Annals  of  Amer.  Acad.  of 

Pol.  and  Soc.  Sci.,  vol.  Ixviii,  Nov.,  1917,  pp.  226-235) 
F.  M.  C.  A.  (West  Side,  New  York) 

Public  Utility  Economics  (Series  of  Addresses,  West  Side,  Y.  M.  G.  A^ 

New  York,  1914,  pp.  195) 


744  INVESTMENT  ANALYSIS 

Railroads 
Bennett,  R.  J. 

(In)    Corporation  Accounting,  pp.  16-29    (New  York,  The  Ronald 

Press  Co.,  1917) 
Bureau  of  Railway  Economics 

Comparative  Railway  Statistics  of  Foreign  Countries,  1913  (Bureau 

of  Railway  Economics,  Wash.  Misc.  Series,  No.  25,  1916,  pp.  78) 

A  Comparative  Statement  of  Physical  Valuation  and  Capitalization 

(Bureau  of  Railway  Economics,  Series  No.  4,  Washington,  D.  C.,  1911, 

pp.  11) 

See  Earning  Statements  and  Other  Pamphlets  Issued  by  this  Bureau. 
Byers,  M.  L. 

Economics  of  Railway  Operation   (New  York,  Eng.  News  Pub.  Co., 

1908,  pp.  672) 
Clark,  G.  A. 

A  Recent  Development  in  Railroad  Finance  (Railway  Age  Gaz.,  vol. 

Iviii,  No.  6,  June  IS,  1915,  pp.  1418-1420) 
Cleveland  and  Powell 

Railroad   Promotion   and   Capitalizations    (New  York   and   London, 

Longmans  &  Greene,  1912,  pp.  462) 

Railroad  Finance  (New  York  and  London,  Appleton,  1912,  pp.  461) 
Chamberlain,  Lawrence 

Railroad  Bonds,    (In)    Principles  of  Bond  Investments,  pp.  252-313 

(New  York,  Henry  Holt  &  Co.,  1913) 
Coverdale,  W.  H. 

The  Existing  Steam  Railroad  Structure  (Proc.  of  the  Third  Annual 

Convention  of  the  Investment  Bankers  Assoc.,  1914,  pp.  161-179) 
Conway  and  Atwood 

Railroad  Bonds,  (In)  Investment  and  Speculation,  pp.  214-269  (New 

York,  Alexander  Hamilton  Institute,  1914) 
Crozier,  J.  B. 

Railroad  Bonds,  (In)  The  First  Principles  of  Investments,  pp.  30-78 

(Finan.  Rev.  of  Rev.,  1910,  pp.  168) 
Dewing,  Arthur  S. 

Railroad  Equipment  Obligations   (Amer.  Econ.  Rev.,  vol.  vii,  No.  2, 

June,  1917,  pp.  353-376) 
Dunn,  S.  O. 

The  Interstate  Commerce  Commission  and  the  Railroads  (Annals  of 

Amer.   Acad.   of  Pol.   and   Soc.   Sci.,   vol.   Ixiii,   No.   152,   Jan.,  1916, 

pp.  173-182) 
Eaton,  James  Shirley 

Railroad   Operations;   How   to  Know  Them  from   a   Study   of  the 

Accounts  and  Statistics  (New  York,  R.  R.  Gazette,  1900,  pp.  313) 
Fisher,  J.  A. 

Railway  Accounts  and  Finance  (London,  George  Allen;  New  York, 

Van  Nostrand,  1916) 


APPENDIX  745 

Greene,  Thomas  Lyman 

Railway   Bonds,    (In)    Corporation  Finance,  pp.  83-62,  pp.   102-130 

(New  York,  Putnam's  Sons,  Third  Edition,  1913) 
Hadley,  Arthur  Twining    (Chairman) 

Report  of  the  Railroad  Securities  Commission  to  the  President  (Wash. 

Gov.  Print'g.  Office,  1911,  pp.  44) 
Heft,  Louis 

Holders  of  the  Railroad  Bonds  and  Notes ;  Their  Rights  and  Remedies 

(New  York,  Button  &  Co.,  1916,  pp.  419) 
Henry,  George  Garr 

Railroad  Bond.  (In)  How  to  Invest  Money,  pp.  23-GO  (New  York  and 

London,  Funk  &  Wagnalls  Co.,  1908) 
Hooper,  William  E. 

Railroad  Accounting  (New  York  and  London,  Appleton  &  Co.,  1915. 

pp.  461) 
Huebner,  S.  S. 

Distribution  of  Stock  Holdings  in  American  Railways    (Annals  of 

Amer.  Acad.  of  Pol.  and  Soc.  Sci.,  vol.  xxli,  No.  3,  Nov.,  1903,  pp.  63-72) 
Investment  Bankers  Association  Committee 

Report  of  Committee  on  Railroad  Bonds  and  Equipment  Trusts  (Pro- 
ceedings of  the  Third  Annual  Convention,  1914,  pp.  38-50) 
Jordan,  David  F. 

Railroad  Securities,  (In)  Investments,  pp.  111-124  (New  York,  Pren- 
tice-Hall &  Co.,  1920) 
Jenks,  J.  W.,  Edwin  W.  Kemmerer,  and  J.  A.  Tillinghast 

Securities  of  Industrial  Combinations  and  Railroads  (United  States, 

Ind.  Com.  Report,  Washington,  1901,  xiii,  913-45,  U.  S.  Doc.  Serial 

4343) 
Knoop,  Douglas 

Outlines  of  Railway  Economics  (London,  Macmillan  &  Co.,  Ltd.,  1913, 

pp.  274) 
Lawson.  W.  R. 

British  Railways ;  A  Financial  and  Commercial  Survey  (New  York, 

Van  Nostrand  Co.,  1914,  pp.  320) 
Lisman,  F.  J. 

Railroad  Bonds   (Annals  of  Amer.  Acad.  of  Pol.  and  Soc.  Sci.,  vol. 

Ixxxviii,  Mar.,  1920,  pp.  57-63) 
Lovett,  R.  S. 

Statement  Before  the  Railroad  Securities  Commission,  1910    (New 

York,  C.  G.  Burgoyne,  1910,  Pamphlet,  pp.  38) 
McLean,  Simon  J. 

Canadian  Railroads  and  the  Bonding  Question  (Jour,  of  Pol.  Econ., 

vol.  vii,  No.  4,  Sept.,  1899,  pp.  500-543) 
Meade,  E.  S. 

Railroad  Bonds,  (In)  The  Careful  Investor,  pp.  115-133  (Philadelphia 

and  London,  Lippincott  &  Co.,  1914) 


746  INVESTMENT  ANALYSIS 

Meyers,  H.  B. 

Memorandum  Relating  to  Analysis  of  Railroad  Reports  (National 
Assoc.  of  Ry.  Comm.,  1907,  pp.  103-112,  Proceedings  of  18th  Annual 
Convention) 

Mitchell,  T.  W. 

Types  of  Railroad  Mortgages  (Jour,  of  Acct,  vol.  i,  No.  5,  1906, 
pp.  357-371) 

Moody,  John 

Railroad  Bonds,    (In)   The  Art  of  Wall  Street  Investing,  pp.  75-99 
(Revised  Edition,  New  York,  Moody  Corporation,  1916) 
How  to  Analyze  Railroad  Reports    (New  York,  Moody's  Investors 
Service,  1919,  pp.  218,  Fifth  Edition) 

Mundy,  Floyd  W. 

Railroad  Bonds  as  an  Investment  Security  (Annals  of  Amer.  Acad.  of 
Pol.  and  Soc.  Sci..  vol.  xxx.  No.  2,  1907,  pp.  312-335) 
The  Earning  Power  of  Railroads   (Annual),  "With  Tables  and  Notes 
(New  York,  Oliphant  Service,  1920) 

Price  Waterhouse  and  Company 

Railroad  Statistics,  Comparative  Operating  Statistics  of  Fifty-three 
Principle  Railroads  in  the  United  States  (New  York,  Price  Water- 
house  &  Co.,  1911) 

Ripley,  William  Z. 

Railroads.  Finance  and  Organization  (New  York,  Longmans,  Green 
&  Co.,  1915,  2  Volumes) 

Raymond,  William  L. 

Railroad  Bonds,  (In)  American  and  Foreign  Investment  Bonds, 
pp.  162-197  (Boston  and  New  York,  Houghton  Mifflin  Co.,  1916) 

Ripley,  William  Z. 

Railroad  Construction  Finance  in  America  (Railway  Age  Gazette, 
May  29,  June  5,  1914,  vol.  Ivi.  No.  5,  pp.  1225-59) 

Sakolski,  Aaron  Morton 

American  Railroad  Economics  (New  York,  The  Macmillan  Co.,  1913, 
pp.  295) 

Snyder,  Carl 

Railroad  Stocks  as  Investments  (Annals  of  Amer.  Acad.,  vol.  xxxv, 
No.  5,  May,  1910,  pp.  164-175) 

Stevens,  W.  J. 

Investment  and  Speculation  in  British  Railways  (London,  E.  Wilson, 
1902,  pp.  262) 

Suffern  &  Son 

Railroad  Operating  Costs  a  Series  of  Original  Studies  in  the  Operat- 
ing Costs  of  Leading  American  Railroads  (New  York,  Suffern  &  Sons, 
1911) 

United  States  Interstate  Commerce  Commission  Bulletins  on  Accounting 
for  Railroads,  Issued  at  Irregular  Intervals. 


APPENDIX  747 

United  States  Interstate  Commerce  Commission  Annual  Report  of  the 

Statistics    of    Railways   in    the   United    States,    Washington,    since 

1887. 
Van  Oss,  S.  F. 

American  Railroads  as  Investments  (New  York,  G.  P.  Putnam's  Sons, 

1S93,  pp.  188) 
Warburg,  P.  W. 

Stabilizing   Railroad   Investments    (National  Inst.   Soc.    Sci.,   Jour., 

June  1,  1919,  pp.  12) 
Woodlock,  Thomas  F. 

The  Anatomy  of  a  Railroad  Report  (Nelson's  Wall  Street  Library, 

vol.  ii,  N.  Y.,  Doubleday,  Page  &  Co.,  1909,  pp.  121) 
Williams,  William  Henry 

Letter  to  the  Railroad  Securities  Commission,  etc.,  Pertaining  to  the 

Issuance  of  Stocks  and  Bonds    (New  York,  Jan.  18,  1911,  pp.  64, 

Reprint  pamphlet) 

Real  Estate  Bonds  and  Mortgages 

Adams,  Thos.  S. 

The  Wisconsin  Tax  Commission  Valuation  of  Real  Estate  (Minn. 
Acad.  Arts  and  Sci.,  vol.  i,  pp.  79-104) 

Bannister,  J.  C. 

How  Buildings  Were  Appraised  in  Revaluation  of  Real  Property  of 
Los  Angeles  (Eng.  Record,  April  8,  1916,  pp.  472-475) 

Bernard,  A.  D. 

Some  Principles  and  Problems  of  Real  Estate  Valuation :  Data  Com- 
piled and  Cost  Prices  Fixed  (Baltimore,  U.  S.  Fidelity  &  Guaranty 
Co.,  1913,  pp.  150) 

Bolton,  R.  P. 

Building  for  Profit ;  Principles  Governing  the  Economic  Improvement 
of  Real  Estate  (New  York,  The  DeVinne  Press,  1911,  pp.  124) 

Campbell,  Robert  Argyel 

Mortgage  Taxation  (Wisconsin  Library  Commission,  Legislative  Ref- 
erence Department,  1908,  Comparative  Legislative  Bulletin,  No.  17) 

Chamberlain,  Lawrence 

Bonds  Versus  Mortgages  (Moody's  Magazine,  vol.  xv,  No.  3.  Mar. 
1913,  pp.  199-203) 

Real  Estate  Bonds,  (In)  The  Principles  of  Bond  Investments, 
pp.  366-374  (New  York,  Henry  Holt  &  Co.,  1913) 

Gloss,  G.  M.  and  Farmer,  H.  J. 

Manual  for  Appraising  Real  Estate  and  Buildings  Approved  Practical 
Methods  (Milwaukee:  C.  N.  Caspar  Co.,  1916,  pp.  59) 

Craigen,  George  John 

Practical  Methods  of  Appraising  Lands,  Buildings  ari  Improvements 
(New  York,  G.  J.  Craigne,  1911,  pp.  126) 


748  INVESTMENT  ANALYSIS 

Durfee,  E.  N.,  (Editor) 

Cases  on  the  Law  of  Mortgages,  Selected  and  Anotated  (Indianapolis: 

Bobbs-Merrill,  1915,  pp.  531) 
Henry  George  Garr 

Real  Estate  Mortgages,   (In)  How  to  Invest  Money,  pp.  51-62  (New 

York,  Funk  &  Wagnalls,  1908) 
Herrick,  M.  T. 

Rural  Credits:    Land  and  Cooperative   (New  York,  Appleton,  1916, 

pp.  519) 
Hertel,  H. 

Bankers'  Scientific  Appraisal  System  for  Land  Buildings  (Cleveland, 

O.,  Bankers'  Appraisal  Co.,  1919,  pp.  30) 
Kurd,  Richard  Melanthou 

Principles  of  City  Land  Values   (New  York,  The  Record  &  Guide, 

1903,  pp.  159) 

Real  Estate  Bonds  as  Investment  Securities  (Annals  of  Ainer.  Acad., 

vol.  xxx,  No.  2,  Sept.,  1907,  pp.  158-181) 

Distribution  of  Urban  Land  Values   (Yale  Rev.,  vol.  xi,  Aug.,  1902, 

pp.  124-145) 
King,  Wilford  Isbell 

The  Valuation  of  Urban  Realty  for  Purposes  of  Taxation,  With  Cer- 
tain Sections  Especially  Applicable  to  Wisconsin    (Madison,  Bulletin 

of  Univ.  of  Wis.,  1914,  pp.  133-246) 
Life  Insurance  Investments  and  Farm  Mortgages 

Investigation  Included  126  Companies,   Showing  Where  the  Money 

Was   Loaned.      Shows    the   geographical   distribution    of    the   loans. 

(Proceedings  of  the  Ninth  Annual  Meeting  of  the  Association  of  Life 

Insurance  Presidents,  New  York,  1915,  pp.  146) 
Linder,  Walter 

Mortgages  (In)  Insurance  and  Real  Estates,  pp.  342-3T1,  402-420,  439- 

448  (New  York,  Alexander  Hamilton  Institute,  1911) 
Lutz,  H.  L. 

The  Somers  System  of  Realty  Valuation  (Quart.  Jour,  of  Econ.,  vol. 

xxv,  Nov.,  1910,  pp.  172-181) 
Happin,  W.  F. 

Farm  Mortgages  and  the  Small  Farmer   (Pol.  Sci.,  Quart.,  vol.  i.v, 

No.  3,  Sept.,  1889,  pp.  432-452) 
Mead,  Edward  Sherwood 

Mortgages    (In)    The  Careful   Investor,   pp.   185-205    (Philadelphia, 

Lippincott  Co.,  1914) 
Hurd,  Richard  Melanthon 

Principles  of  City  Land  Values   (New  York,  The  Record  &  Guide, 

1903,  pp.  159) 
Mixter,  Chas.  W. 

Farm  Mortgages  and  Double  Taxation  in  Vermont  (State  and  Local 

Taxation,  Proceedings,  vol.  i,  1907,  pp.  358-372) 


APPENDIX  749 

Myrick,  Herbert 

The  Federal  Farm  Loan  System  (New  York,  Organe  Judd  Co.,  1916, 

pp.  239) 
Otis,  C.  A. 

Report  of  Committee  on  Real  Estate  Bonds  (I.  B.  A.  of  A.  Bulletin, 

vol.  iv,  No.  7,  April  8,  191G,  pp.  101-104) 
Purdy,  Lavvson 

The  Valuation  and  Assessment  of  City  Real  Estate  (Rhode  Island. 

Tax  Officials  Assoc.,  Bulletin  No.  1,  Jan.,  1916,  pp.  5-14) 
Putnam,  G.  E. 

The  Federal  Rural  Credit  Bill  (Arner.  Econ.  Rev.,  vol.  vi,  No.  4,  Dec., 

1916,  pp.  770-790) 
Reed,  Homer 

The  Science  of  Real  Estate  and  Mortgage  Investment  (Kansas  City, 

Hudson  Kumberly  Pub.  Co.,  1899,  pp.  124) 
Robins,  Kingman  Nott 

Farm  Mortgage  Handbook   (Garden  City,  N.  Y.,  Doubleday,  Page  & 

Co.,  1916,  pp.  241) 
Robinson,  C.  F. 

The  Mortgage  Recording  Tax    (Pol.  Sci,  Quart.,  vol.  v,  Dec.,  1910, 

pp.  609-624) 
Somers,  W.  A. 

The  Valuation  of  Real  Estate  for  Taxation   (National  Munic.  Rev., 

vol.  vi,  No.  2,  April,  1913,  pp.  230-239) 
Straus,  S.  W. 

Safeguarding  First  Mortgage  Leasehold  Bonds   ( Moody 's  Magazine, 

vol.  xv,  No.  3,  Mar.,  1913,  pp.  215-221) 
Thompson,  C.  W. 

The  Federal  Farm  Loan  Act  (Amer.  Econ.  Rev.,  vol.  vii,  No.  1,  Mar., 

1916,  pp.  115-132) 
United  States  (Department  of  Agriculture) 

Factors  Affecting  Interest  Rates  and  Other  Charges  on  Short  Time 

Farm  Loans  (Bulletin  No.  409,  of  the  Federal  Department  of  Agri- 
culture, C.  W.  Thompson,   Specialist  in  Rural  Organization,  Wash- 
ington, D.  C.,  August  26,  1916) 
United  States  (Department  of  Agriculture) 

(By)    Truesdell,    L.    E.,    Amortization   Methods   of   Farm    Mortgage 

Loans,  Cir.  No.  60  (Washington,  Dept.  Agric.,  Office  of  the  Secretary, 

1916,  pp.  12) 
Virtue,  G.  O. 

Mortgage  Taxation  in  Nebraska   (Quart.  Jour,  of  Econ.,  vol.  xxvii, 

No.  4,  Aug.,  1913,  pp.  695-699) 
West  Side  Y.  M.  C.  A.  (New  York) 

Practical  Real  Estate  Methods,  Edited  by  W.  H.  Britigan  and  George 

W.  Wharton  (New  York,  Doubleday,  Page  &  Co..  1910,  pp.  397) 


750  INVESTMENT  ANALYSIS 

Receivers'  Certificates    (See  Bonds) 
Regulation  of  Security  Issues  by  the  States 

Anderson,  William 

The  Work  of  the  Public  Service  Commissions  with  Special  Reference 
to  the  New  York  Commerce  (Univ.  of  Minn.,  Current  Problems,  No.  1, 
Bulletin  of  Univ.  of  Minn.,  Nov.,  1913,  pp.  44) 
Ayres,  Arthur  V. 

Regulation  of  Securities  Issued  (Pol.  Sci.  Quart.,  vol.  xxviii,  No.  4, 
Dec.,  1913,  pp.  586-593) 
Barren,  Mary  L. 

State  Regulation  of  the  Securities  of  Railroads  and  Public  Service 
Companies  (Annals  of  the  Amer.  Acad.  of  Pol.  and  Soc.  Sci.,  vol.  Ixxvi, 
No.  165,  Mar.,  1918,  pp.  167-190) 
Bauer,  John 

Relieving  the  Investors'  Uncertainty  (Elec.  Railway  Jour.,  vol.  xlvii, 
Mar.  11,  1916,  pp.  491-494) 
Bullock,  C.  J. 

Control   of    the    Capitalization    of    Public    Service   Corporations    in 
Massachusetts   (Amer.  Econ.  Assoc.  Rev.,  vol.  x,  No.  1,  Apr.,  1909, 
pp.  84-85) 
Conway,  Thomas,  Jr. 

Railroad  Security  Issues  Under  Government  Operation    (Annals  of 
Amer.  Acad.  of  Pol.  and  Soc.  Sci.,  vol.  Ixxvi,  Mar.,  1918,  pp.  111-120) 
Dewsnup,  Ernest  Ritson 

Recent  Financial  Investigation  of  Interstate  Commerce  Commission 
(Annals  of  Amer.  Acad.  of  Pol.  and  Soc.  Sci.,  vol.  Ixiii,  Jan.,  1916, 
pp.  199-212) 
Erickson,  Halford 

Government  Regulation  of  Security  Issues  of  Public  Utility  Corpora- 
tions (Madison  Democrat  Printing  Co.,  1911,  State  Printer,  pp.  66) 
Fink,  H. 

Federal  Regulation  of  Railroad  Securities  and  Valuation  of  Railroads 
(Roanoke,  Virginia,  Stone  Printing  Company,  1911,  pp.  37) 
Geisse,  H.  L. 

Attitude  of  Wisconsin,  Comm.  Security  Issues  (Elec.  Railway  Jour., 
vol.  xlvii,  No.  13,  Mar.  25,  1916,  pp.  602-603) 
Hadley,  Arthur  L. 

Report  of  the  Railroad  Securities  Commission  to  the  President  (Wash. 
Gov.  Print'g.  Office,  1911,  pp.  44) 
Heilman,  Ralph  E. 

The  Control  of  Interstate  Utility  Capitalization  by  State  Commis- 
sions (Jour,  of  Pol.  Econ.,  vol.  xxiv,  No.  5,  May,  1916,  pp.  474-489) 
Investment  Bankers'  Association  Bulletins 

See  Various  Bulletins  Issued  and  References  to  Blue  Sky  Legislation 


APPENDIX  751 

in  the  Regular  Bulletins  of  this  Organization  which  are  the  Best 
Current  References  Issued  on  this  Subject. 

Lyon,  W.  H. 

Capitalization  and  the  State,   (In)  Capitalization,  Part  I,  chap,  viii, 
pp.  220-285  (New  York,  Houghton  Mifflin  &  Co.,  1912) 
Shall  the  Government  Regulate  the  Sale  of  Securities  (Annals  of  the 
Amer.  Acad.  of  Pol.  and  Soc.   Sci.,   vol.  Ixiii,  No.  152,  Jan.,  1916, 
pp.  255-262) 

Meyer,  H.  H.  B. 

List  of  Recent  Reference  on  Public  Service  Rates  With  Special 
Reference  to  Regulation  (Special  Libraries,  February,  1916,  pp.  8) 

Miller,  E.  X.  T. 

The  Texas  Stock  and  Bond  Law  and  Its  Administration  (Quart. 
Jour,  of  Econ.,  vol.  xxii,  No.  1,  Nov.,  1907,  pp.  108-119) 

Mundy,  Floyd  W. 

Federal  Regulations  of  Railroad  Stock  and  Bond  Issues  (Moody 
Magazine,  vol.  xii,  1911,  pp.  101,  105  and  192-198) 

New  York  Public  Service  Commission  of  Second  District 

Regulation  of  Public  Utilities  (Annual  Report  of  the  N.  Y.  Pub, 
Service  Comm.  of  the  Sec.  Dist,  vol.  i,  1913,  pp.  106-11) 

Potts,  Charles  Shirley 

Texas  and  Bond  Law  (Annals  of  Amer.  Acad.  of  Pol.  and  Soc.  Sci., 
vol.  liii,  No.  142,  May,  1914,  pp.  162-171) 

Control  of  Capitalization,  the  Stock  and  Bond  Law  (Texas),  (Bul- 
letin of  the  Univ.  of  Texas,  Mar.  1,  1909,  On  Railroad  Transportation 
In  Texas,  chap,  ix) 

Proceedings  of  the  First  Annual  Convention  of  the  National  Associations 
of  Securities  Commissioners  (Annual,  First  Session,  March,  1918) 

Rollins,  Montgomery 

Laws  Regulating  the  Investment  of  Bank  Funds  (Boston,  Mont- 
gomery Rollins ;  Current  changes  in  laws  of  state  relative  to  change 
furnished  on  detachable  leaves.  Fourth  Edition,  1905,  pp.  184) 

State  Regulation  of  Public  Utilities  Upon  Municipal  Home  Rule  (Annals 
of  Amer.  Acad.  of  Pol.  and  Soc.  Sci.,  vol.  liii,  No.  142,  May,  1914, 
pp.  357) 

Thelen,  Max 

Desirable  Scope  and  Method  of  Federal  Regulation  of  Security 
Issues  (Annals  of  Amer.  Acad.  of  Pol.  and  Soc.  Sci.,  vol.  Ixxvi, 
No.  165,  Mar.,  1918,  pp.  191-201) 

Thompson,  R.  A. 

Regulation  of  the  Issuance  of  Texas  R.  R.  Securities  by  the  State 
Government  (Texas  Acad.  of  Sci..  Trans..  Austin,  vol.  v.,  1903, 
pp.  1-17) 

United  States  Congress  Commission  of  House  of  Representatives  on 
H.  R.  on  Interstate  and  Foreign  Commission  to  Limit  Issue  of  Stocks 
and  Bonds  (Wash.  Gov.  Print'g.  Office,  1908,  pp.  13) 


752  INVESTMENT  ANALYSIS 

United  States  Regulation  of  Security  Issues,  Report  of  the  R.  R.  Securi- 
ties Commission,  House  of  Representatives,  62nd  Congress,  2nd  Ses- 
sion, Doc.  No.  256,  Nov.  1,  1911) 

Warburg,  Paul  M. 

Shrinkage  in  Public  Utility  Securities  and  Their  Relation  to  War 
Financing  (Jour,  of  the  Amer.  Bankers'  Assoc.,  vol.  xii,  No.  1,  July, 
1918,  pp.  14-17) 

Williams,  W.  H. 

Letter  to  Railroad  Securities  Commission  (New  York,  Jan.  18,  1911, 
pp.  64,  pamphlet) 

Savings  Banks  and  Trusteeship  Laws   (See  Legal,  etc.) 

Selling  of  Securities  (See  Also  Markets) 
Black,  W.  H. 

Real  Wall  Street:    Understandable  Description  of  a  Purchase,   a 

Sale,   a    Short    Sale    (New   York,    Corporation   Organization,    1908, 

Pamphlet,  pp.  69) 
Campbell,  Douglass 

The  Law  of  Stockbrokers  with  Reference  to  Transactions  for  Cus- 
tomers on  the  New  York  Stock  Exchange  (New  York,  Baker,  Voorhis 

&  Co.,  1914,  pp.  114) 
Conant,  C.  A. 

Selling  American  Securities  Abroad  (North  Amer.,  vol.  clxxxiii,  Sept., 

1906,  pp.  508) 
Conway  and  Atwood 

Selling  of  Securities,    (In)    Investment  and   Speculation,  pp.  29-53 

(New  York,  Alexander  Hamilton  Institute,  1914) 
Chamberlain,  Lawrence 

The  Work  of  the  Bond  House  (New  York,  The  Moody  Magazine  Book 

Co.,  1913,  pp.  157) 
Cooper,  Francis 

Financing  an  Enterprise,  vol.  ii,  pp.  253-403    (Third  Edition,  New 

York,  The  Ronald  Press,  1909) 
Crozier,  John  Beattie 

Selling   of    Securities,    (In)    The  First   Principles   of   Investments, 

pp.  105-163  (London,  The  Financial  Rev.  of  Rev.,  1910) 
Foley,  William 

Organization  and  Management  of  a  Bond  House  (Annals  of  Amer. 

Acad.  of  Pol.  and  Soc.  Sci.,  vol.  xxx,  No.  3,  Sept.,  1907,  pp.  257-263) 
Haney,  Lewis  H. 

Marketing  and  the  Stock  Exchange,  (In)  Business  Organization  and 

Combinations,  pp.  312-326  (New  York,  The  Macmillan  Company,  1913) 
Huebener,  S.  S. 

The  Scope  and  Functions  of  the  Stock  Market    (Annals  of  Amer. 

Acad.  of  Pol.  and  Soc,  Sci.,  vol.  xxxv,  No.  3,  May,  1910,  pp.  483-505) 


APPENDIX  753 

Jordan,  David  F. 

Listing  on  the  Exchanges,  (in)  Investments:  chap,  xviii,  pp.  243-255, 

Mechanics  of  Purchase  and  Sale ,  chap,  xix,  pp.  255-265 ;  Work  of  the 

Bond  Houses,  chap,  xvii,  pp.  229-243  (New  York.  Prentice-Hall,  1920) 
Lough,  Wiliam  H. 

Underwriting,    (In)   Corporation  Finance,  pp.  223-279    (New   York, 

Alexander  Hamilton  Institute,  1913) 

Underwriting,   (In)  Business  Finance,  pp.  291-338  (New  York,  The 

Ronald  Press  Co.,  1917) 
Lyons,  Hastings 

Syndicates ;  Joint  Accounts  and  Underwritings,  Corporation  Finance, 

Part  I,  pp.  200-219;  Part  II,  chaps,  i,  ii,  iii,  pp.  1-156   (New  York, 

Hough  ton  Mifflin  &  Co.,  1916) 

The  Work  of  An  Investment  Banking  House   (Annals  Amer.  Acad. 

of  Pol.  and  Soc.  Sci.,  vol.  Ixxxviii,  Mar.,  1920,  pp.  34-43) 
M'Ewan,  A. 

The  Securities  Department  of  a  Branch  Bank:    A  Brief  Outline  of 

Its  Work  (Scottish  Bankers  Magazine,  July,  1915,  pp.  13) 
Meade,  Edward  Sherwood 

Sale  of  Securities,  (In)  Corporation  Finance,  pp.  114-141  (New  York, 

Appleton  Co.,  1920) 

The  Banking  House  as  an  Aid  to  Investors,  (In)  The  Careful  Investor, 

pp.  61-82   (Philadelphia  and  London,  Lippincott  Co.,  1914) 
Norton,  Eliot 

The  Purchase  or  Sale  of  Securities  Through  a  Stock  Broker  (Annals 

of  Amer.  Acad.  of  Pol.  and  Soc.  Sci.,  vol.  xxxv,  No.  3,  May,  1910, 

pp.  506-524) 
Pavey,  T.  D. 

Sale  of  American  Securities  in  France  (North  Amer.,  vol.  cxc,  Dec., 

1906,  No.  6,  pp.  811-818) 
Pratt,  Sereno  S. 

The  Work  of  Wall  Street  (New  York,  Appleton  &  Co.,  Revised  Ed., 

1920) 

Selling  American  Bonds  in  Europe   (Annals  of  Amer.  Acad.  of  Pol. 

and  Soc.  Sci.,  vol.  xxx,  No.  2,  Sept.,  1907,  pp.  269-283) 
Smith,  A. 

The  Abuse  of  the  Audit  in  Selling  Securities  (Jour,  of  Acct,  vol.  xiv, 

No.  4,  Oct.,  1912,  pp.  243-254) 

Serial  Payments  and  Sinking  Fund 
Anyon,  James  T. 

Sinking  Fund  and  Reserve  Accounts  (Jour,  of  Acct.,  vol.  vii,  No.  3, 

Jan.,  1908-9,  pp.  185-192) 
Bennett,  R.  J. 

Amortization,  (In)  Corporation  Accounting,  pp.  390-468  (New  York, 

The  Ronald  Press,  1917) 


754  INVESTMENT  ANALYSIS 

Dougharty,  Harold 

Annuities  and  Sinking  Funds,  Simple  and  Compound  Interest  Tables 

with  Notes  (London,  E.  Wilson,  1906,  pp.  52) 
Gibbs,  J.  W. 

Policy  of  Railway  Sinking  Funds   (The  Railway  Age  Gaz.,  No.  8, 

Aug.,  1911,  pp.  360-361) 
Hatfield,  Henry  Rand 

Amortization,   (In)  Modern  Accounting,  pp.  261-273   (New  York  and 

London,  Appleton  &  Co.,  1911) 
Keys,  C.  M. 

Bond  Redemption  and  Sinking  Funds    (Annals  of  Amer.  Acad.  of 

Pol.  and  Soc.  ScL,  vol.  xxx,  No.  2,  Sept.,  1907,  pp.  213-229) 
Leake,  P.  D. 

The  Use  and  Misuse  of  the  Sinking  Fund  (London,  Gee  &  Co.,  1913; 

Also  the  Accountant,  vol.  xlvii,  No.  1982,  Nov.  23,  1912,  pp.  663-669) 
Lownhaupt,  Frederick 

Sinking  Fund  and  Social  Payment,   (In)  Investment  Bonds,  pp.  225- 

237   (New  York,  G.  P.  Putnam's  Sons,  1908) 
Lyon,  W.  H. 

Amortization,  (In)  Capitalization,  pp.  144-165  (New  York,  Houghton 

Mifflin  Co.,  1912) 
Macpherson,  F.  H. 

Sinking  Funds  Principles  and  Practices  (Jour,  of  Acer.,  vol.  xiv,  No.  2, 

Aug.,  1912,  pp.  113-117) 
Massachusetts 

Report  of  Special  Investigation  Relative  to  the  Sinking  Funds  and 

Serial  Loans  of  the  Cities  and  Towns  of  Massachusetts  (In  House, 

Doc.  No.  2006-226,  Feb.,  Mar.?  1913) 
Panborn,  Warrel  S. 

Sinking  Fund  Reserves   (Jour,  of  Acct,  vol.  xii,  No.  4,  Aug.,  1911, 

pp.  262-268) 
Pen-in,  J.  W. 

History  of  the  Cleveland  Sinking  Fund  of  1862  (Cleveland,  O.,  Globe 

Printing  Co.,  1913,  pp.  68) 
Public  Debt — Recommendation  of  Legislation  as  to   Sinking  Fund   of 

Treasury  (U.  S.  Treas.  Dept.  Pub.  Doc.,  Feb.,  1911,  pp.  473) 
Ross,  Edward  A. 

Sinking   Funds    (Amer.    Econ.    Assoc.,   vol.   vii,    Supplement,    1892, 

pp.  311-416) 
Thomas,  E.  S. 

Determination  of  Income  Rates  on  Serial  Bonds  Unusual   (Jour,  of 

Acct.,  vol.  xxiv.  No.  2.  Aug..  1917,  pp.  105-111) 
Turner,  Edward  Hartley 

The  Repayment  of  Local  and  Other  Loans,   Sinking  Funds    (Man- 
chester, Eng.,  Univ.  Press,  1913,  pp.  536) 


APPENDIX  755 

Special  Assessments   (See  Municipals) 

Speculation 
Conway  and  Atwood 

Speculation,    (In)    Investment   and    Speculations,   pp.   96-128    (New 

York,  Alexander  Hamilton  Inst.,  1914) 
Crump,  Arthur 

The  Theory  of  Stock  Exchange  Speculation  (New  York,  S.  A.  Nelson, 

1912,  pp.  114) 
England,  M.  T. 

On  Speculation  in  Relation  to  the  World's  Prosperity    (1897-1902), 

(Univ.  of  Neb.  Studies,  May  5,  1906,  pp.  107) 
Emery,  H.  C. 

Place  of  Speculation  on  the  Theory  of  Distribution    (Amer.  Econ. 

Assoc.,  vol.  i,  No.  1,  Dec.,  1900,  pp.  103-114) 

Speculation  on  the   Stock   and   Produce   Exchanges   in   the   United 

States  (New  York,  The  Macmillan  Co.,  1897,  pp.  230) 
Gibson,  Thomas 

The  Cycles  of  Speculation  (New  York,  Moody  Magazine  Corp.,  1907, 

pp.  187) 

The  Pitfalls  of  Speculation  (New  York,  Moody  Magazine  Corp.,  Re- 
vised, 1916,  pp.  184) 
Henry,  George  Garr 

Market   Movements   of   Speculation,    (In)    How    to   Invest   Money, 

pp.  108-121  (New  York  and  London,  Funk  &  Wagnalls,  1908) 
Higgins,  Leonard  R. 

The  Put  and  Call  (London,  Effingham,  Wilson,  1906,  pp.  76) 
Hollander,  Jacob 

Bank  Loans  and  Stock  Speculation  (61  Cong.  2nd  Sess.  Sen.  Doc.,  589, 

pp.  27.    In  National  Monetary  Commerce  Reports,  op.  1916) 
Investment  Bankers'  Association  of  America 

The  Stock  Exchange  Business;  A  Course  of  Study  with  References 

(New  York,  Doubleday,  Page  &  Co.,  for  I.  B.  Assoc.  of  Amer.,  1918, 

pp.  98) 
Kemmerer,  E.  W. 

The  Higgling  of  the  Market  (Quart.  Jour,  of  Econ.,  vol.  xvii,  No.  4, 

Aug.,  1903,  pp.  670-677) 
Mason,  F.  W. 

Working  of  German  Law  Against  Speculation   (U.  S.  Consular  Re- 
ports, vol.  Ixiv,  pp.  438-444) 
Nelson,  S.  A. 

The  Consolidated  Stock  Exchange  of  New  York   (New  York,  A.  B. 

Bensch  Co..  1906,  pp.  124) 

The  A.  B.  C.  of  Options  and  Arbitrage  (New  York,  S.  A.  Nelson,  1904. 

PP.  87) 

A.  B  C.  of  Wall  Street  (New  York,  S.  A.  Nelson.  1913,  pp.  164) 


756  INVESTMENT  ANALYSIS 

New   1'ork  Committee  on  Speculation  in  Securities  and  Commodities; 

Report  of  June  7,  1909,  submitted  to  the  legislature  by  the  governor 

with  his  annual  message,  June  5,  1910,  pp.  23    (Printed  by  Lyon, 

Report  of  Governor  Hughes  Committee  on  Speculation  in  Securities 

and  Commodities,  June  7,  1909) 
Norton,  Eliot 

On  Short  Sale  of  Securities  Through  a  Stock  Broker  (New  York, 

J.  McBride  Co.,  1907,  pp.  72) 
Pratt,  S.  S. 

The  Case  for  Speculation  (Jour,  of  Acct.,  vol.  vi,  No.  1,  May,  1908, 

pp.  1-10) 
Ripley,  Z. 

Railway  Speculation   (Quart.  Jour,  of  Econ.,  vol.  xxv,  No.  2,  Feb., 

1911,  pp.  185-215) 
Smithey,  Robert  Lincoln 

You  and  Your  Broker  (See  Bibliography  on  Speculation,  pp.  211-226), 

(New  York,  Magazine  of  Wall  Street,  1920) 
White,  Horace 

Hughes  Investigation    (Jour,  of  Pol.  Econ.,  vol.  xvii,  No.  28,  Oct., 

1909,  pp.  528-540) 

State  Bonds 
Bogart,  E.  L. 

The  State  Debt  of  Ohio,  1825-1911    (Jour,  of  Pol.  Econ.,  vol.  xix, 

April,  1911,  pp.  249-68) 
Chamberlain,  Lawrence 

State  Bonds,    (In)   The  Principles  of  Bond  Investments,  pp.  122-158 

(New  York,  Henry  Holt  Co.,  1913) 
Conway  and  Atwood 

State  Bonds,    (In)    Investments  and  Speculation,  pp.  102-18*    (New 

York,  Alexander  Hamilton  Institute,  1914) 
Gephert,  W.  F. 

The  Growth  of  State  and  Local  Expenditures  (Proceeding  Nat'l.  Tax 

Assoc.,  1908,  pp.  53-525) 
Jordan,  David  F. 

State  Bonds,   (In)  Investments,  chap,  v,  pp.  42-61  (New  York,  Pren- 
tice-Hall &  Co.,  1920) 
Miller,  E.  T. 

Repudiation  of  State  Debt  Since  1861  (Southeastern  History  Quart., 

Oct.,  1912,  pp.  13) 
Raymond,  William  L. 

State  Bonds,  (In)  American  and  Foreign  Investment  Bonds,  pp.  94- 

139   (Boston  and  New  York,  Houghton  Mifflin  &  Co.,  1916) 
Randall,  J.  G. 

The  Virginia  Debt  Controversy    (Pol.   Sci.  Quart.,  vol.  xxx,  No.  4, 

Dec.,  1915,  pp.  553-78) 


APPENDIX  757 

Scott,  W.  A. 

The  Repudiation  of  State  Debts   (New  York.  Crowell  &  Co.,   1898. 

pp.  325) 
United  States 

Statistical  Abstract  of  the  United  States  will  give  Annual  Current 

Information  (Annual) 

Steamship  Bonds 
Chamberlain,  Lawrence 

(In)   The  Principles  of  Bond  Investments,  pp.  314-319   (New  York. 

Henry  Holt  Co.,  1913) 

Stocks 

Adams,  John,  Jr. 

Stocks  and  Their  Features,  A  Division  and  Classification  (Annals  of 

Amer.   Acad.   of  Pol.   and   Soc.   Sci.,   vol.   xxxv,   No.   3,   May,   1910. 

pp.  43-62) 
Annals  of  American  Academy  of  Political  and  Social  Science 

Stocks  and  Their  Stock  Market  (Annals  of  Amer.  Acad.  of  Pol.  and 

Soc.  Sci.,  vol.  xxxv,  No.  3,  1910,  pp.  236  [See  Index  for  titles]) 
Bentley,  H.  C. 

Preferred  Stock,  (In)  Corporation  Finance  and  Accounting,  pp.  404- 

417  (New  York,  Ronald  Press,  1908) 
Burgunder,  R.  R. 

The  Declaration  and  Yield  of  Stockholders'  Rights  (Annals  of  Amer. 

Acad.  of  Pol.  and  Soc.  Sci.,  vol.  xxxv,  No.  3,  May,  1910,  pp.  554-578) 
Cooper,  Francis 

Stocks,  (In)  Financing  an  Enterprise,  vol.  ii,  pp.  404-436  (New  York, 

The  Ronald  Press,  Fourth  Edition) 
Greene,  Thomas  L. 

Stocks,    (In)   Corporation  Finance,  Third  Edition,  chap,  i   (London 

and  New  York,  G.  P.  Putnam  Sons,  1908) 
Harvey,  Richard  Selden 

Rights  of  the  Minority  Stockholder  (New  York,  Baker  Voorhis  &  Co.. 

1909,  pp.  164) 
Henry,  George  Gave 

Stocks,   (In)  How  to  Invest  Money,  pp.  100-107  (New  York,  Funk  & 

Wagnalls  Co.,  1908) 
Lough,  W.  H. 

Stocks,   (In)   Business  Finance,  pp.  64-104   (New  York,  The  Ronald 

Press  Co.,  1917,  pp.  561) 

Stocks,    (In)   Corporation  Finance,  pp.  65-78    (New  York,  Alexander 

Hamilton  Institute  Series,  1909) 
Lyon,  W.  H. 

Stocks,  (In)  Capitalization,  pp.  1-29  (Boston  and  New  York,  Hough- 
ton  Mifflin  Co.,  1912) 


758  INVESTMENT  ANALYSIS 

Meade,  Edward  Sherwood 

Industrial  Preferred  Stock,    (In)   The  Careful  Investor,  pp.  232-243 

(Philadelphia  and  London,  Lippincott,  1914) 
Meyer,  Edgar  W. 

Industrial  Stocks  As  Investments  (Annals  of  Amer.  Acad.  of  Pol.  and 

Soc.  Sci.,  vol.  xxxv,  No.  3,  May,  1910,  pp.  545-553) 
Norton,  L.  A. 

Stocks  of  Financial  Institutions  (Annals  of  Amer.  Acad.  of  Pol.  and 

Soc.  Sci.,  vol.  xxxv,  No.  3,  May,  1910,  pp.  197-206) 
Sullivan,  John  J. 

Corporation  Stocks,    (In)   American  Corporations,  pp.  194-201    (New 

York  and  London,  Appleton  &  Co.,  1910) 
Snyder,  Carl 

Railroad  Stocks  As  Investments  (Annals  of  Amer.  Acad.  of  Pol.  and 

Soc.  Sci.,  vol.  xxxv,  No.  3,  May,  1910,  pp.  164-174) 
Sunley,  W.  T. 

Treasury  Stock  (Jour,  of  Acct.,  vol.  xx,  No.  5,  Dec.,  1915,  pp.  424-30) 
Underwood,  Arthur  W. 

Liability  for  Unpaid  Subscriptions   (Jour,  of  Acct.,  vol.  xviii,  No.  1, 

May,  1909,  pp.  17-33) 
Withers,  Hartley 

Stocks,  (In)  Stocks  and  Shares,  pp.  217-282  (London,  Smith,  Elder  & 

Co.,  1911,  Second  Edition) 

Stock  Exchange 
Aubrey,  W.  H.  A. 

Stock  Exchange  Investments,  Theory  Methods,  Practice  and  Results 

(New  York,  Charles  Scribner  &  Sons,  1896) 
Atwood,  Albert  William 

The  Exchanges  and   Speculation    (New  York,   Alexander  Hamilton 

Institute,  1917,  pp.  334) 
Burn,  Joseph 

Stock  Exchange  Investments  in  Theory  and  Practice  with  Chapters 

on  the  Constitution  and  Operations  of  the  Bank  of  England  and  the 

National  and  Local  Debts  of  the  United  Kingdom   (London,  Charles 

and  Edward  Lay  ton,  pp.  332) 
Conway  and  Atwood 

Stock  Exchange  Organization,  (In)  Investment  Speculation,  pp.  15-28, 

54-95  (New  York,  Alexander  Hamilton  Institute,  1914) 
Crump,  A. 

The  Theory  of  Stock  Exchange  Speculation  (New  York,  Rosenbaum, 

1887,  pp.  134) 
Chevilliard,  G. 

Stock  Exchange  (London,  Effingham  &  Wilson,  1904,  pp.  262) 
Cordingley,  William  George 

Guide   to    Stock    Exchanges    (London,    Effingham    &    Wilson,    1910, 

pp.  130) 


APPENDIX  759 

Conant,  Charles  A. 

Function  of  the  Stock  and  Produce  Exchanges    (Atlantic  Monthly. 

vol.  xci,  April,  1903,  pp.  433-442) 
Clews,  Henry 

Fifty  Years  in  Wall  Street  (New  York,  Irving  Pub.  Co.,  1908,  pp.  1062) 
Dos  Passos,  J.  R. 

A  Treatise  on  the  Law  of  Stock  Brokers  and  Stock  Exchanges  (New 

York,  Bankers'  Law  Pub.  Co.,  1905,  2  Vols.) 
Duguid,  Charles 

The  Stock  Exchange  (London,  Methuen  &  Co.,  1904,  pp.  173) 
Emery,  Henry  Crosby 

Speculation  on  the  Stock  and  Produce  Exchange  of  the  United  States, 

Columbia  Studies  in  History,  Economics  and  Public  Law,  vol.  vii, 

1896,  pp.  283) 

Ten  Years'  Regulation  of  the  Stock  Exchange  in  Germany  (Yale  Rev., 

vol.  xvii,  No.  1,  May,  1908,  pp.  5-23) 
Friend,  Emil 

Stock  Exchange  Regulation  in  Germany  (Jour,  of  Pol.  Econ.,  vol.  xvi, 

No.  5,  June,  1908,  pp.  369-374) 
Gibson,  G.  R. 

Stock  Exchanges  in  London,  Paris  and  New  York  (New  York,  G.  P. 

Putnam  &  Sons,  1889,  pp.  125) 
Goldman,  Samuel  P. 

A  Handbook  of  Stock  Exchange  Laws,  Affecting  Members,  Their  Cus- 
tomers, Brokers  and  Investors  (New  York,  Doubleday,  Page  &  Co., 

1914,  pp.  290) 
Granwood,  W.  J. 

Foreign  Stock  Exchange  and  Company  Laws  (New  York,  Financial 

Book  Co.,  1911,  pp.  270) 
Hirst,  Francis  Wrigley 

The  Stock  Exchange,  A  Short  Study  of  Investment  and  Speculation 

(New  York,  Henry  Holt  &  Co.,  1911,  vol.  vii,  pp.  256) 
Hastings,  Lyon 

Listing  on  the  Stock  Exchange,   (In)  Corporation  Finance,  Part  II, 

chap,  iv,  pp.  157-175  (New  York,  Houghton  Mifflin  &  Co.,  1916) 
Huebner,  S.  S. 

The  Scope  and  Functions  of  the  Stock  Market    (Annals  of  Amer. 

Acad.  of  Pol.  and  Soc.  Sci.,  vol.  xxxv,  No.  3,  May,  1910,  pp.  1-23) 

Bibliography  on  Securities  and  Stock  Exchanges   (Annals  of  Amer. 

Acad.    of    Pol.    and    Soc.    Sci.,    vol.    xxxv,    No.    3,    May,  1910,  pp. 

217-231) 
Ingalls,  G.  D.  and  Withers,  G. 

Stock    Exchange    (New    York    and    London,    Longmans    &    Green. 

1904,  pp.  295) 
King,  M. 

The  New  York  Stock  Exchange  (New  York,  M.  King,  1904) 


760  INVESTMENT  ANALYSIS 

Legs,  C.  A. 

The  Law  of  Commercial  Exchanges  (New  York,  Baker,  Voorhis  &  Co., 

1913,  pp.  381) 
Lexis,  W. 

New  German  Exchange  (The  Econ.  Jour.,  vol.  vii,  No.  20,  Sept,  1897, 

pp.  368-384) 
Lowenfleld,  Henry 

Stock  Exchanges,   (In)  All  About  Investment,  pp.  116-162   (London, 

the  Financial  Rev.  of  Rev.,  1909) 
Martin,  H.  S. 

The  New  York  Stock  Exchange  (New  York,  F.  E.  Fitch,  1919.  pp.  27?) 
Martin,  J.  G. 

Boston  Stock  Market  (Boston,  Pub.  by  Author,  1886,  pp.  152) 
Meyer,  E.  (Jr.) 

New  York  Stock  Exchange  and  the  Panic  of  1907   (Yale  Rev.,  vol. 

xviii,  No.  1,  May,  1909,  pp.  34-46) 
Moody,  John 

The  Stock  Exchange,     (In)    The    Art    of    Wall    Street    Investing, 

pp.  135-151   (New  York,  Moody  Corp.,  1906) 
Nelson,  S.  A. 

The  Consolidated  Stock  Exchange  of  New  York  (New  York,  A.  B. 

Benesch  Co.,  1907,  pp.  124) 
Ordway,  S.  H. 

Speculation  and  Stock  Exchanges  (Scribner's  Magazine,  vol.  xl.,  Sept., 

1909,  pp.  370-377) 
Poley,  A.  P.  and  Gould,  F.  H.  C. 

The  History,  Law  and  Practice  of  the  Stock  Exchange  (London,  Pit- 
man, 1911,  pp.  354) 
Pratt,  Serono  S. 

The  Work  of  Wall  Street  (New  York,  Appleton  &  Co.,  Revised  Ed., 

1921,  pp.  447) 
Rollins,  Montgomery 

Stocks  and  Stock  Market  Places   (Boston,  Dana  Ested  &  Co.,  1911, 

pp.  211) 
Selden,  C.  G. 

Psychology  of  the  Stock  Market  (New  York,  Ticker  Pub.  Co.,  1912, 

pp.  120) 
Stedman,  L.  L.  and  Easton,  A.  W. 

New  York  Stock  Exchange   (New  York,  Stock  Exchange  Hist.  Co., 

1905) 
Van  Antwerp,  W.  C. 

The  Stock  Exchange  From  Within   (New  York,  Doubleday,  Page  & 

Co.,  1913,  pp.  459) 
Villard,  Oswald  Garrison 

Early  History  of  Wall  Street  (New  York,  G.  P.  Putnam's  Sons,  1S97, 

pp.  140) 


APPENDIX  761 

Withers,  Hartley 

Stock  and  Shares  (New  York,  Dutton  &  Co.,  1911,  pp.  371) 

Street  Railways  Securities    (See  also  Public  Utilities  Securities) 

Allen,  A.  F. 

Operating  Statistics  for  Street  Railways  (Jour,  of  Acct.,  voL  iv, 
No.  3,  July,  1907,  pp.  211-215) 

American  Street  and  Interurban  Railway  Association 

Organized  December,  1882,  as  the  American  Street  Railway  Associa- 
tion; Name  Changed  September,  1905,  to  the  American  Street  and 
Interurbau  Railway  and  October,  1910,  to  present  form  (See  Index  of 
Annual  Proceedings) 

American  Electric  Railway  Association 

Problems  of  the  Industry,  American  Electric  Railway  Association, 
Atlantic  City,  Convention,  October,  1911  (New  York,  The  Associa- 
tion, 1911,  pp.  120) 

American  Electric  Railway  Accountants'  Association 

Proceedings  of  the  American  Street  and  Interurban  Accountants  As- 
sociation (Street  Railway  Accountancy  Association,  September,  1905, 
October,  1910,  American  Street  and  Interurban  Railway  Accountancy 
Association,  October,  1910,  American  Electric  Railway  Accountants' 
Association) 

Arnold,  Bion  J. 

The  Return  on  the  Investment  of  the  Subway  of  the  Interborough 
Rapid  Transit  Company  of  New  York  City;  Submitted  to  Public 
Service  Commission  of  the  First  District  of  the  State  of  New  York, 
Report  No.  7,  December  31,  1908,  pp.  21  (Public  Service  Commission, 
New  York) 

Report  on  the  Pittsburg  Transportation  Problem ;  Submitted  to  Hon- 
orable William  A.  Magee,  Mayor  of  Pittsburg,  December,  1910,  pp.  202. 
Report  on  the  Engineering  and  Operating  Features  of  the  Chicago 
Transportation  Problem ;  Submitted  to  the  Committee  on  Local 
Transportation  of  the  Chicago  City  Council,  November,  1902,  pp.  310. 
Report  on  the  Improvement  and  Development  of  the  Transportation 
Facilities  of  San  Francisco ;  Submitted  to  the  Mayor  and  the  Board 
of  Supervisors  City  of  San  Francisco  (San  Francisco,  The  Hicks 
Judd  Company,  1913,  pp.  475) 

Baker,  Fred  Abbott 

Duration  of  Municipal  Streets  Grants  (Detroit,  Michigan,  Record 
Printing  Co.,  1910,  pp.  380) 

Barcroft,  Frederick  T. 

Report  and  Appraisal  of  the  Detroit  United  Railway  (City  Lines), 
October  1,  1909  (Edited  by  Norman  Flowers  and  Edward  C.  Dunbar. 
Detroit,  Michigan,  J.  Mack  Printing  House,  1910,  pp.  237) 

Bemis,  E.  W. 

The  Street  Railway  Settlement  in  Cleveland  (Qr.art.  Jour,  of  Econ., 


762  INVESTMENT  ANALYSIS 

vol.  xxii,  No.  4,    Aug.,    1908,    pp.    543-576,    vol.    xxiv,    May,    1910, 

pp.  550-560) 
Boston  Elevated  Railway  (by  John  A.  Beeler) 

Report   and   Appraisal   of  the  Boston   Elevated   Railway   Company 

(Boston,  Massachusetts,  to  the  Public  Service  Commission,  Common- 
wealth of  Massachusetts,  Nov.,  1917,  pp.  280) 
Brockway,  Walter  B. 

Electric  Railway  Accounting   (New  York,  McGraw  Pub.  Co.,  1906, 

PP.  84) 
Buck,  A.  Morris 

The  Electric  Railway  (New  York,  McGraw-Hill  &  Co.,  1915,  pp.  390) 
Chamberlain,  Lawrence 

Street  Railway  Bonds,    (In)    The  Principles  of  Bond  Investments, 

pp.  320-337  (New  York,  Henry  Holt  &  Co.,  1911) 
Commercial  and  Financial  Chronicle 

The  Commercial  and  Financial  Chronicle,  Electric  Railway  Section 

(New  York,  W.  B.  Dana  Company,  Since  1895) 
Conway  and  Atwood 

Electrical  Railways,    (In)    Investment  and  Speculation,  pp.  292-334 

(New  York,  Alexander  Hamilton  Institute,  1914) 
Cunningham,  Wallace  McCook 

Electric  R.  R.  Stocks  (Annals  of  Amer.  Acad.  of  Pol.  and  Soc.  Sci., 

vol.  xxxv,  No.  3,  pp.  175-191) 
Deming,  Clarence 

The  Trolley   Competition  with  Railroads    (Eng.  Magazine,  vol.  ix, 

No.  5,  Aug.,  1S95,  pp.  823-831) 
Doolittle,  F.  W. 

Studies  in  the  Cost  of  Urban  Transportation  Service,  Bureau  of  Fare 

Research,  American  Electric  Railway  Association  (New  York,  Amer. 

Electric  Railway  Assoc.,  1916,  pp.  467) 

Some  Problems  of  the  Electric  Railway   Industry    (Elec.   Railway 

Jour.,  vol.  xlvii,  No.  23,  June  3,  1916,  pp.  1035-1039) 

Railway  Operation  in  Cleveland  (Elec.  Railway  Jour.,  vol.  xvii,  No.  8, 

Feb.  19,  1916,  pp.  359-365) 
Duffy,  C.  N. 

Economics  of  the  Cleveland  Railway  Situation  as  Developed  in  the 

year  1913    (Elec.  Railway  Jour.,  vol.  xlii,  No.  15B,  Oct.  15,  1913, 

pp.  770-774) 
Emery,  J.  A. 

Statistical  Units  Used  in  Analysis  of  Electrical  Railway  Accounts 

(Elec.  Railway  Jour.,  vol.  xlii,  No.  150,  Oct.  16,  1913,  pp.  815-818) 
Erickson,  Halford 

Some  Problems  of  Public  Utility  Accounting   (Elec.  Railway  Jour., 

vol.  xliii,  No.  6,  Feb.  7,  1914,  pp.  306-307) 


APPENDIX  763 

Fairlie,  J.  A. 

The   Street  Railway  Question  in   Chicago    (Quart.  Jour,   of  Econ., 

vol.  xxi,  No.  3,  May,  1907,  pp.  371-404) 
Fischer,  Louis  Engleman 

Economics  of  Interurban  Railways   (New  York,  McGraw-Hill  Book, 

1914,  pp.  116) 
Fisher,  J.  A. 

Railway  Accounts  and  Finance  (London,  G.  Allen  Co.,  1912,  pp.  586) 
Haney,  L.  H. 

Joint  Costs  with  Especial  Regard  to  Railways  (Quart.  Jour,  of  Econ., 

vol.  xxx,  No.  2,  Feb.,  1916,  pp.  233-253) 
Heilman,  Ralph  E. 

Chicago  Traction  Company  (New  York,  Amer.  Econ.  Assoc.,  voL  ix, 

No.  2,  1908,  pp.  131) 
Higgins,  Edward  E. 

Street  Railway  Investments;  A  Study  in  Values  (New  York,  Street 

R.  R.  Pub.  Co.,  1894,  pp.  102) 
Holt,  Robert  Bickerstaffe 

Tramway  Truck  Construction  and  Maintenance  (London,  Tramway 

and  Railway  World  Offices,  1915,  pp.  249) 
Hopkins,  W.  R. 

Street  Railways  in  Cleveland  (Economic  Studies,  vol.  i,  1896,  No.  1, 

pp.  289-355) 
Jackson,  Dugald  Caleb 

Street  Railway  Fares,  Their  Relation  to  Length  of  Haul  and  Cost  of 

Service ;  Report  of  Investigation  Carried  on  in  the  Research  Division 

of  the  Massachusetts  Institute  of  Technology,  by  Dugald  C.  Jackson 

and  David  J.  McGratt    (New  York,  McGraw-Hill  Book   Co.,  1917, 

pp.  169) 
King,  Dr.  Clyde  L. 

A  Study  of  Trolley  Light  Freight  Service  and  Philadelphia  Markets 

in  Their  Bearing  on  the  Cost  of  Farm  Produce  (Department  of  Public 

Works,  City  Hall,  Philadelphia,  1912,  pp.  58) 
Little,  A.  S.  B. 

Comporting  Profits  Rates  and  Fair  Returns   (Gas  Age,  vol.  xxxix, 

Mar.  15,  1917,  pp.  285-287) 
Los  Angeles  Public  Utilities  Board 

Report  No.  1,  Valuation  of  Street  and  Interurban  Railway  Lines  in 
the  City  of  Los  Angeles  (Los  Angeles,  1914,  pp.  32) 
Mattersdorf,  Wilhelm 

An  Analysis  of  Street  Railway  Operation   (Street  Railway  Jour., 
vol.  xix,  No.  14,  Apr.  15,  1902,  pp.  439-441) 

Influences  Determining  Street  Railway  Traffic  in  Germany   (Street 
Ry.  Jour.,  vol.  xxvii,  No.  22,  June  2,  1906,  pp.  844-848) 


764  INVESTMENT  ANALYSIS 

May,  Irville  Augustus 

Street  Railway  Accounting,  A  Manual  of  Operating  Practice  (New 
York,  The  Ronald  Press  Co.,  1917,  pp.  454) 

McGraw's  American  Street  Railway  Manual,  The  Red  Book  of  American 
Railways  of  the  United  States,  Canada,  Cuba,  Indies  (ceased  pub- 
lication in  1914),  (New  York,  McGraw  Publishing  Co.,  Published 
1894-1914) 

McLain,  F.  D. 

The  Street  Railways  of  Philadelphia  (Quart.  Jour,  of  Econ.,  vol.  xxii, 
No.  2,  Feb.,  1908,  pp.  233-2CO) 

Municipal  Reference  Library  of  the  City  of  Chicago 

Reference  Bulletin  No.  3  (Prepared  under  the  direction  of  Theodore 
K.  Long,  A  Study  of  Rapid  Transit  in  Seven  Cities,  July,  1914, 
pp.  27) 

Nash,  L.  R. 

Financial  Problems  of  Electric  Railways  (Stone  and  Webster,  Jour. 
Pub.  Service,  June,  1916,  vol.  xviii,  pp.  441-456) 

The  Cleveland  Railway  Situation  (Stone  &  Webster  Pub.  Service 
Jour.,  vol.  xviii,  Feb.,  1910,  pp.  124-158) 

New  York  (State)  Public  Service  Commission,  1st  District 

Uniform  System  of  Accounts  of  Street  and  Electric  Railways. 

Norton,  Samuel  Wibler 

Chicago  Traction;  A  History  Legislative  and  Political  (Chicago, 
S.  W.  Norton,  1907,  pp.  240) 

Ontario,  Railway  and  Municipal  Board  Annual  Reports  (1st  Report, 
1906),  (Toronto) 

Parsons,  Barclay  &  Klapp,  New  York 

Report  on  Detroit  Street  Railway  Traffic  and  Proposed  Subway  Made 
to  Board  of  Street  Railway  Commissioners  (City  of  Detroit,  1915, 
pp.  299) 

Philadelphia  Department  of  City  Transit 

Special  Report  on  Rapid  Transit  Development  for  Philadelphia  (Sub- 
mitted to  the  Select  Common  Councils  of  Philadelphia ;  Submitted 
by  A.  M.  Taylor;  Philadelphia,  1915,  pp.  42) 

Report  of  Committee  on  Cost  of  Passenger  Transportation  Service 

(Electric  Railway  Jour.,  vol.  xliii,  No.  25,  June  20, 1914,  pp.  13S3-13S9) 

Sprague,  F.  J. 

Electric  Railroads ;  Some  Facts  and  Problems  Bearing  on  Electric 
Trunk-line  Operation  (Wash.  Gov.  Printg.  Office,  In  Smithsonian  Re- 
port, 1907,  pp.  131-161) 

The  History  and  Development  of  Electric  Railways,  (In)  The  Pro- 
ceedings Electrical  Railways  International  Electrical  Congress,  St. 
Louis,  1904,  pp.  1-20) 

Stearns 

Zone  Fares  in  Milwaukee  (Elec.  Railway  Jour.,  vol.  xlv,  No.  18, 
May  1,  1915,  pp.  836-838) 


APPENDIX  765 

States 

Classification  of  Public  Utility  Accounts  (A  Number  of  the  States, 
as  for  example  Wisconsin,  New  York,  Massachusetts,  California, 
etc.,  have  classifications  that  are  worth  careful  study.  These  are 
usually  printed  and  can  be  obtained  from  the  Secretary  of  the  respec- 
tive Commissions) 

Street  Railway  Association  of  the  State  of  New  York;  See  New  York 
Electric  Railway  Association  (Organized  in  1883  as  Street  Railway 
Association  of  the  State  of  New  York) 

Street  Railway  Journal 

General  Index  to  the  Street  Railway  Journal  by  Subjects  and  Author, 
October,  1884,  to  December,  1903,  including  vols.  i-xxii  (New  York, 
McGraw  Pub.  Co.,  1904,  pp.  162 

Toll,  R.  W. 

Traffic  Investigations  in  Denver  (Elec.  Railway  Jour.,  vol.  xliv,  No.  9, 
Aug.  29,  1914,  pp.  3SO-3S3) 

United  States  Bureau  of  Census 

Bureau  of  Census  Street  and  Electric  Railways,  1902 ;  Prepared  under 
the  supervision  of  W.  M.  Stewart,  chief  statistician  for  manufac- 
turers (Wash.  Gov.  Printg.  Office,  pp.  439) 

Report  on  Transportation  Business  in  United  States,  Census  1890, 
pp.  891-940  (Wash.  Gov.  Printg.  Office,  1891) 

Electric  Railways  Census  for  1917  (Wash.  Gov.  Print'g.  Office,  1920, 
pp.  171) 

Bureau  of  Census,  Street  Railways  Central  Electric  Light  and  Power 
Stations  and  Street  and  Electric  Railways  with  Summary  of  Elec- 
trical Industry  (Bulletin  No.  124,  1914,  Wash.  Gov.  Print'g.  Office, 
1915,  pp.  440) 

Walker,  George  N. 

Interurban  Railways,  Study  of  Values,  Boston  (Boston,  Skinner, 
Kidder  Co.,  1901,  pp.  16) 

Weber,  A.  F. 

Maintenance  and  Depreciation  (Elec.  Ry.  Jour.,  vol.  xlvi,  No.  15,  Oct. 
9,  1915,  pp.  705-707) 

Wilcox,  O.  B. 

Competition  With  Other  Investments  (Elec.  Ry.  Jour.,  vol.  xlvii, 
Xo.  6,  Feb.  5,  1916,  pp.  241) 

Tables  (Bond  and  Interest  Tables  and  Sinking  Fund  Tables) 
Archer,  J. 

Compound  Interest  Annuity  and  Sinking  Fund  Tables  (London,  Shaw 

&  Sons,  1907,  pp.  180) 
Bartholomew,  J.  R. 

Direct  Reading  Interest  Tables   (New  York,  Lee,  Higginson  &  Co., 

1915,  pp.  63) 


766  INVESTMENT  ANALYSIS 

Delbridge,  C.  L. 

Interest  Tables,  Day  to  365  Days  on  Sums  from  $1  to  $100,000  at 
Rates  of  %%  to  12%  (St.  Louis,  The  Delbridge  Co.,  1916,  pp.  371) 

Dughee,  Joseph 

Dughee's  Table  of  Bond  Values  (Library  Edition),  (New  York,  G.  W. 
Dougherty,  1908,  pp.  46*) 

Farr,  A.  G. 

Bond  Tables  Giving  Present  Values  of  Bonds  Bearing  Interest  Rates 
from  1%  to  3%  Payable  Semi-annually  (Chicago  and  New  York, 
N.  W.  Harris  &  Co.,  1908,  pp.  183) 

Greenough,  Alfred 

Tables  of  Short  Time  Bond  Values  (New  York,  Kissel,  Kennicutt  & 
Co.,  1916,  pp.  183) 

Laurie,  J. 

High-rate  tables  of  simple  interest  at  5,  6,  7,  8,  9  and  y2  per  cent 
per  annum  from  1  day  to  100  days,  1  month  to  12  months ;  also 
copious  tables  of  commissions  or  brokerage  from  %  to  10  per  cent 
(New  York,  Dutton,  1919,  pp.  238) 

Mackenzie,  M.  G. 

Interest  and  Bond  Values  (Toronto,  University  Press,  1912,  pp.  94) 

Robinson,  James  Watts 

Robinsonian  5,  6,  7,  and  8  per  cent  interest  book.  Computed  on  basis 
of  360  days  to  the  year  to  which  are  added  tables  of  interest  on 
daily  balances,  on  360  days'  basis  at  1%,  2,  2y2,  3y2,  4,  4%  and  5  per 
cent  on  any  amount  from  $1  to  $100,000,000,  arranged  also  for  aver- 
aging accounts  (New  Orleans,  J.  W.  Robinson,  1910) 
Robinsonian  Multiplication  and  Division  Tables  giving  at  sight  the 
products  of  numbers  from  1  to  1,000  by  all  numbers  from  1  to  100  and 
by  the  fractional  sixteenths  (Second  Edition,  New  Orleans,  J.  W. 
Robinson,  1912,  pp.  108) 

Rollins,  Montgomery 

Partial  Payment  Tables  Showing  What  is  Required  to  Repay  a  Loan 

of  Equal   Amounts   of   Combined   Principal   and   Interest    (Boston, 

M.  Rollins,  1912,  pp.  21) 

Tables  of  Bond  Values :   Theory  and  Use  (Annals  of  Amer.  Acad.  of 

Pol.  and  Soc.  Sci.,  vol.  Ixxxviii,  Mar.,  1920,  pp.  12-23) 

Odd  rates  tables  of  bond  values  for  computing  the  prices  of  bonds 

and  other  redeemable  securities  paying  interest  semi-annually  at  any 

rate,  for  yields  from  2.90  to  6  per  cent  and  maturing  in  periods  from 

6  months  to  50  years ;  together  with  special  tables,  from  4%  and  5^ 

per  cent  rates  (Boston,  Montgomery  Rollins,  1912,  pp.  99) 

Sprague,  Charles  E. 

Extended  Bond  Tables  to  Eight  Places  (New  York,  Ronald  Press, 
1914,  pp.  234) 

The  Accountancy  of  Investments  (New  York,  Ronald  Press,  1914. 
pp.  371 ) 


APPENDIX  767 

United  States  Treasury  Department,  by  Jos.   S.  McCoy   (Government 
actuary ) 

Tables  showing  prices  of  2,  3,  and  4  per  cent  bonds,  interest  payable 
quarterly,  corresponding  to  investment  values  of  from  *4  per  cent  to 
3  per  cent  per  annum,  from  %  year  to  20  and  30  years  to  maturity  of 
bond,  with  a  simple  interest  table  (Pub.  1908,  Wash.  Gov.  Printg. 
Treas.  Dept,  Doc.  No.  2531) 

Taxation  of  Securities 

Adams,  T.  S. 

The  Wisconsin  Income  Tax  (Amer.  Econ.  Rev.,  vol.  i,  No.  4,  Dec., 
1911,  pp.  906-918) 

Mortgage  Statistics  and  Taxation  (Report  of  Wisconsin  Tax  Com- 
mission, 1907) 

Blackmore,  A.  W.  and  Bancroft,  H. 

The  Inheritance  Tax  Law  (Boston,  The  Boston  Park  Co.,  1912, 
pp.  1376) 

Brown,  A.  O. 

Common  Methods  of  Valuing  Property  for  Taxation  (Fourth  Annual 
Report  N.  H.  Tax  Commission  Report,  1914,  pp.  19-30) 

Bullock,  Charles  J. 

The  Federal  Income  Tax  (Proceedings  of  the  National  Tax  Assoc., 
1914,  pp.  264-279) 

The  Taxation  of  Property  and  Income  in  Massachusetts  (Quart. 
Jour,  of  Econ.,  vol.  xxxi,  Nov.,  1916,  pp.  1-61) 

The  Position  of  the  Inheritance  Tax  in  American  Taxation  (Pro- 
ceedings of  Nat'l  Tax  Assoc.,  1907,  vol.  i,  pp.  231-240) 

Campbell,  Robert  A. 

Mortgage  Taxation  (Madison,  Wisconsin,  Library  Committee,  1908, 
pp.  60) 

Clapperton,  George 

Federal  Taxation  of  Incomes  and  Inheritances  (Fifth  Conference  on 
Taxation,  Michigan,  1916,  pp.  19-32) 

Chamberlain,  Lawrence 

Income  Tax  and  Security  Prices  (Moody's  Magazine,  vol.  xvl,  No.  5, 
Nov.,  1913,  pp.  205-209) 

Chassell,  Ed.  D.  and  Robins,  K.  N. 

The  Case  For  and  Against  Tax  Exemption  of  United  States  Govern- 
ment Bonds  and  Federal  Farm  Loan  Bonds  (Chicago,  Farm  Mort- 
gage Bankers  Associations  of  America,  1919,  pp.  38) 

Compton,  W. 

Recent  Tendencies  in  the  Report  of  Forest  Taxation  (Jour,  of  PoL 
Econ.,  vol.  xxiii,  No.  10,  Dec.,  1915,  pp.  971-980) 

Corporation  Trust  Companies  Services  (Annual) 
(See  also  the  other  Services  of  this  Company) 


768  INVESTMENT  ANALYSIS 

Endelman,  E. 

Investment  Bonds  and  Tax  Exemption  Laws  (New  York,  McAuliffe 

and  Booth,  1915,  pp.  75) 
Fuller,  O.  B. 

Taxation  of  Mortgages    (Michigan   Tax   Assoc.    Proceedings,   1917, 

pp.  16-27) 
Guaranty  Trust  Company   (New  York) 

The  Federal  Income  Tax  Law  and  Rulings  Affecting  Individuals  and 

Fiduciaries  (New  York,  Guaranty  Trust  Company ;  this  contains  not 

only  an  index  of  the  law,  but  an  index  to  the  rulings,  1919,  pp.  67) 

The  Federal  Estate  Tax  Law  and  Regulations  (New  York,  Guaranty 

Trust  Co.,  1916,  pp.  35) 

The  Secured  Debts  Tax  Law  of  the  State  of  New  York  (New  York; 

Guaranty  Trust  Co.,  1916,  pp.  56) 
Goodnow,  F.  J. 

The  Nature  of  Tax  Exemption  (Colorado  Law  Rev.,  Feb.,  1916,  pp.  17) 
Goudy,  Frank  C. 

Taxation  of  Irrigated  Lands   (Proceedings  of  National  Tax  Assoc., 

vol.  iv,  1914,  pp.  27-32) 
Haig,  R.  M. 

The  Effects   of  Increment  Taxes   Upon   High   Building   Operations 

(Quart.  Jour,  of  Econ.,  vol.  xxix,  No.  4,  Aug.,  1915,  pp.  829-840) 
Harrington,  John 

Taxation  of  Stock  and  Securities  Under  the  Inheritance  Tax  Law 

(Proceedings  of  Nat'l  Tax  and,  vol.  vi.,  1916,  pp.  303-320) 
Huebner,  S. 

The  Inheritance  Tax  in  the  American  Commonwealths  (Quart.  Jour. 

of  Econ.,  vol.  xviii,  1904,  pp.  529) 
Investment  Bankers'  Association 

Report  of  Taxation  Committee   (I.  B.  of  A.  Bulletin,  May  12,  1914, 

pp.  11-21) 
Jordan,  David  F. 

Relation  to  Taxation,  (In)  Investments,  chap,  xxiii,  pp.  319-330  (New 

York,  Prentice-Hall  Co.,  1920) 
Kennedy,  J.  T. 

Dividends  and  New  Income  Tax  Law  (Jour,  of  Acct.,  vol.  xxiv,  No.  lv 

Jan.,  1917,  pp.  39-43) 
King,  W.  I. 

The  Valuation  of  Urban  Realty  for  Purposes  of  Taxation  (Bulletin, 

University  of  Wisconsin,  Economic  and  Political  Science,  vol.  viii, 

No.  2,  1914) 
Kinsman,  D.  O. 

The  Present  Period  of  Income  Tax  Activity  in  the  American  States 

(Quart.  Jour,  of  Econ.,  vol.  xxiii,  Feb.,  1909,  pp.  296-305) 


APPENDIX  769 

Lounhaupt,  Frederick 

Taxation,  (In)  Investment  Bonds,  pp.  160-165  (New  York  and  Lou- 
don,  G.  P.  Putnam  &  Sons,  1908) 
Lyon,  W.  H. 

Taxation   of   Securities,   Investment   Bankers   Association   Bulletin 

(I.  B.  A.  Bulletin,  vol.  ii,  No.  15,  Aug.  31,  1914,  pp.  15-25) 
Lyon,  W.  H. 

Double  Taxation  and  Intangibles   (I.  B.  A.  of  A.  Bulletin,  vol.  lii, 

No.  10,  May  25, 1915,  pp.  13-20) 

Principles  of  Taxation   (Houghton  Mifflin  Co.,  1914,  pp.  133) 
Mathews,  N. 

Double  Taxation  of  Mortgaged  Real  Estates  (Quart.  Jour,  of  Econ., 

vol.  iv,  April,  1S90,  pp.  339-348) 
McDonald,  E.  L. 

Taxation  of  Mortgages  in  Kentucky  (Louisville,  Real  Estate  Board, 

1916,  pp.  67) 
McCrea,  Russell  C. 

The  Taxation  of  Personal  Property  in  Pennsylvania   (Quart.  Jour. 

of  Econ.,  vol.  xxi,  No.  1,  Nov.,  1906,  pp.  50-95) 
Mixter,  Charles  W. 

Farm  Mortgages  and  Double  Taxation  in  Vermont — Situation  and 

Remedy   (National  Tax  Association,  Proceedings  1907,  pp.  358-372) 
Millls,  H.  A. 

The  Inheritance  Tax  in  the  American  Commonwealth   (Quart  Jour. 

of  Econ.,  vol.  xix,  No.  2,  Feb.,  1905,  pp.  288) 
Montgomery,  Robert  H. 

Federal   Income   Tax    Law,    (In)    Auditing    Theory    and    Practice, 

pp.  759-866  (New  York,  Ronald  Press,  1916,  pp.  829) 

Income  Tax   Procedure    (Annual,   New   York,   Ronald   Press,   1917, 

pp.  450) 
Osgood,  Roy  C. 

The  Effect  of  Taxations  on  Securities   (Annals  Amer.  Acad.  of  Pol. 

and  Soc.  Sci.,  vol.  xxxviii,  Mar.,  1920,  pp.  144-156) 
Peterson,  Samuel 

The  Taxation  of  Intangible  Assets  in  Texas  (Proceedings  of  National 

Tax  Association,  1907,  pp.  306-312) 
1  lehn,  Carl  C. 

The  Federal  Income  Tax  (Calif.  State  Board  of  Equality  Report  of 

1913-14,  pp.  197-213) 
Furdy,  L. 

Mortgage  Taxation  and  Interest  Rates  (New  York,  Tax  Reform  Asso- 
ciation, 1906,  pp.  19) 
Reed,  Robert  R. 

Legislation  and  the  Income  Tax  (Proceedings  of  the  Second  Annual 


770  INVESTMENT  ANALYSIS 

Convention  of  the  Investment  Bankers  Association,   Chicago,  1913, 

pp.  183-189) 
Report  of  the  Committee  on  Double  Taxation  and  Situs  for  Purposes  of 

Taxation  (Proceedings  of  National  Tax  Association,  1914,  pp.  233-41. 

Also  Analysis  of  Cases  Relating  to   Situs  by  Edmund  F.   Traube, 

pp.  342-361) 
Robins,  K.  N. 

The  Evils  of  Tax  Exemption  as  Applied  to  Securities  (3con.  World, 

vol.  civ,  August  23,  1919,  pp.  3) 
Ryan,  A.  R. 

Municipal  Assessments  (Canadian  Munic.  Jour.,  vol.  xii,  No.  9,  Oct., 

191G,  pp.  537-539) 
Saxe,  Martin 

Exemption  of  Real  and  Personal  Property  from  Taxation   (Bulletin 

of  National  Tax  Association,  vol.  ii,  No.  1,  Oct.,  1916,  pp.  12-14) 
Schiff,  Mortimer  L. 

Some  Aspects  of  the  Income  Tax  (Annals  of  Amer.  Acad.  of  Pol.  & 

Soc.  Sci.,  Mar.,  1915,  pp.  15-31) 
Seligman,  E.  R.  A. 

Essays  on  Taxation  (See  Index)    (New  York  and  London,  The  Mac- 

millan  Co.,  1913,  pp.  707) 
Sutro,  Theodore 

Double  Taxation  of  Inheritances  (State  Conference  on  Taxation,  New 

York,  1911,  pp.  233-242) 

Double  and  Multiple  Taxation  (National  Assoc.  Proceedings,  vol.  ii, 

1908,  pp.  547-557) 
Taylor,  W.  G.  Langworthy 

Multiple  Taxation  of  Credits    (Proceedings  Nat'l.  Tax  Asscciation, 

vol.  i,  1907.  pp.  313-339) 
Trabue,  Edmund  F. 

Analysis  of  Cases  Relating  to  Situs   (Proceedings  of  National  Tax 

Assoc.,  1914,  pp.  242-461) 
Wallace,  C.  L. 

The  Taxation   of  Money   and   Credits    (Minn.    Acad.    of    Soc.    Sci., 

Papers  and  Proceedings  of  the  First  Annual  Meeting,  1907,  pp.  169-185) 
White  and  Kemble,  New  York 

List  of  Railroad  Bonds  and  the  Clauses  Relating  to  the  Deduction  of 

Retention  of  Fundamental  Federal  or  State  Taxes   (New  York,  Th? 

Thomas  Press,  1913,  pp.  185) 
Williams.  W.  D. 

The  Taxation  of  Intangibles  (Texas  Bar  Assoc.  Proc.,  1903,  Austin 

1903,  pp.  156-169) 
Wrightington.  Sydney  R. 

Tax  Exempt  and  Taxable  Investment  Securities.  A  Summary  of  the 
Laws  of  All  the  States  and  the  District  of  Columbia  Relating  to 
the  Taxation  of  Securities  from  the  Standpoint  of  the  Banker  and 
Investor  (New  York,  Financial  Pub.  Co.,  1914,  pp.  267) 


APPENDIX  771 

Telephone  and  Telegraph  Securities 

American  Telephone  &  Telegraph  Company  (Legal  Department,  Commis- 
sion Telephone  Cases,  1911-14,  four  vols.,  i  to  iv,  American  Telephone 
and  Telegraph  Co.,  New  York) 

Telephone  and  Telegraph  Statistics  of  the  World  (Bulletin  No.  4, 
May,  1915,  pp.  35) 

Dickson,  F.  S. 

Telephone  Investments  and  Others  (The  Cuyahoga  Telephone  Com- 
pany, 1905,  pp.  56) 

Jackson,  D.  C.  and  Wm.  B. 

Reports  to  the  Massachusetts  Highway  Commission  on  Telephone 
Rates  for  the  Boston  and  Suburban  Districts  (Wright  &  Porter, 
State  Printers,  Boston,  1910,  pp.  66) 

Interstate  Commerce  Commission's  Uniform  System  of  Accounts  for 
Class — All  Telephone  Companies 

Kingsbury,  J.  E. 

The  Telephone  and  Telegraph  Exchange  (New  York,  Longman  Green 
Co.,  1915,  pp.  558) 

Lee,  John 

The  Economics  of  Telegraphs  and  Telephones  (London,  Sir  Isaac  Pit- 
man &  Sons,  1913,  pp.  86) 

Pan  American  Union 

The  Telephone  in  Latin- America  (Bulletin  of  Pan  American  Union. 
July,  1915,  pp.  36-49) 

United  States  Bureau  of  Census 

Telephone  and  Telegraphs  and  Municipal  Electric  Fire-alarm  and 
Police-patrol  Signaling  Systems,  1914  (Washington,  Bureau  of  the 
Census,  1915,  pp.  208,  Department  Commerce  and  Labor) 

United  States  Department  Commerce  and  Labor 

Telephones  and  Telegraphs  (Bulletin  No.  17  of  the  Department  of 
Commerce  and  Labor,  1902,  Bureau  of  Census,  pp.  49) 

Timber  Securities 
Bullock,  W. 

Timber;  From  the  Forest  to  Its  Use  in  Commerce    (See  Index), 

(London,  Sir  Isaac  Pitman  &  Sons,  1915,  pp.  149) 
Chapman,  Herman  Haupt 

Forest  Valuation  (New  York,  John  Haley  &  Sons,  1915,  pp.  310) 
Chittenden,  A.  K.  and  Irion,  Harry 

The  Taxation  of  Forests  in  Wisconsin  (Madison,  Wis.  Dem.  Printing 

Co.,  1911,  pp.  80) 
Chamberlain,  Lawrence 

Timber  Bonds,  (In)  The  Principles  of  Bond  Investments,  pp.  375-383 

(New  York,  Henry  Holt  &  Co.,  1911) 
Compton,  W. 

Recent  Tendencies  in  the  Reform  of  Forest  Taxation   (Jour,  of  Pol. 

Econ.,  vol.  xxiii,  No.  10,  Dec.,  1915,  pp.  981-990) 


772  INVESTMENT  ANALYSIS 

Draper,  F.  B. 

Some  Facts  About  Timber  Bonds  (Moody  Magazine,  vol.  xi,  No.  2, 
Feb.,  1911,  pp.  99-103) 

Fernow,  B.  E. 

Economics  of  Forestry  (New  York,  Crowell  &  Co.,  1902,  pp.  250) 

Hale,  Henry 

The  Timber  Lauds  of  the  Northwest  (Moody  Magaziue  vol.  v.,  No.  5, 
April,  1907-8,  pp.  297-302) 

Meade,  E.  S. 

Timber  Bonds,  (In)  The  Careful  Investor,  pp.  222-231  (Philadelphia 
and  London,  Lippincott  Co.,  1914) 

McGrath,  T.  S. 

Timber  Bonds  as  Investment  Securities  (Annals  of  Amer.  Acad.  of 
Pol.  and  Soc.  Sci.,  Compiled  by  T.  S.  McGrath,  Supplement,  May, 
1912,  pp.  82) 

Plummer,  E.  G. 

United  States  Department  of  Agriculture,  Forest  Service  Bulletin, 
Washington  Government  Printing  Office,  1912,  pp.  5-36.  Forest  Fires ; 
Their  Causes,  Extent  and  Effects,  with  Summary  of  Recorded  De- 
struction and  Loss  (Wash.  Gov.  Printg.  Office,  October,  1912,  Bulle- 
tin 117) 

Poole,  Clark  L. 

Timber  Bonds  (Proc.  of  the  Second  Annual  Convention  of  the  Invest- 
ment Bankers  Assoc.,  1913) 

Timber  Land  Bonds,  Analyzed  as  Investments  for  Banks  and  Trust 
Co.  (Chicago,  Clark  L.  Poole  &  Co.,  1913,  pp.  80) 
Forest  Finance  (Inland  Press,  Asheville,  N.  C.,  1909,  pp.  44) 

Schenck,  Carl  A. 

Some  Business  Problems  of  Forestry  (Asheville,  N.  C.,  French  Board 
Press,  1910) 

Special  Commission  on  Taxation  of  Woodland  (Report  to  the  General 
Assembly  of  1913,  Hartford  Com.,  1912.  State  Pub.,  February,  1913, 
PP.  54) 

United  States  Bureau  of  Corporations  (Washington) 

The  Lumber  Industry,  pp.  240,  Part  I.,  January  Standing  Timber, 
1913 ;  Part  II.  and  III.,  Concentration  of  July  13,  1914,  timber  owner- 
ship in  important  selected  regions  and  land  holdings  of  large  timber 
owners ;  Part  IV.,  Conditions  in  production,  and  wholesale  distribu- 
tion including  wholesale  prices  (Wash.  Gov.  Printg.  Office,  1914, 
pp.  286) 

Transfer  Securities 

Campbell,  H.  Brau 

Legal  Aspects  of  the  Transfer  of  Securities  (New  York,  Doubleday, 
Page  &  Co.,  for  Investment  Bankers  Assoc.,  1920,  pp.  110) 

Corporation  Trust  Companies ;  Manuals  and  Service 

(Loose-leaf  and  kept  up  to  date  by  addition  of  current  material) 


APPENDIX  773 

Harris,  W.  H. 

The  Law  Governing  the  Issuing  Transfer  and  Collection  of  Municipal 
Bonds  (Cincinnati,  W.  H.  Anderson  Co.,  Second  Edition,  1917,  pp.  359) 

Lowell,  A.  L.  and  F.  C. 

The  Transfer  of  Stock  in  Private  Companies  (Boston,  1884,  pp.  297) 

Lyon,  Hastings 

Transer  of  Securities,   (In)   Corporation  Finance,  Part  I,  chap,  vi., 
pp.  166-200  (New  York,  Houghton  Mifflin  Co.,  pp.  296) 

Maraspin,  F.  L.  and  Driver,  H.  B. 

Fundamental  Principles  of  Stock  Transfers    (Boston,  Published  by 
Boston  Chapter  A.  I.  B.,  1917,  pp.  87) 

Mayberry,  J.  L. 

Rules  Governing  the  Delivery.  Registration  and  Transfer  of  Stocks 
and  Bonds  (New  York,  Westfield  Leader  Press,  1913,  pp.  16) 

Water  Bonds 
Adams,  A.  D. 

The  Holyoke  Case  (Quart.  Jour,  of  Econ.,  vol.  xvii,  No.  4,  Aug.,  1903, 

pp.  643-668) 
Bennett,  C.  G. 

Illinois  Utility  Commission  and  the  Water  Works  Companies  (Amer. 

Water  Works  Assoc.,  vol.  ii,  June,  1915,  pp.  382-389) 
Burgess,  P. 

Points  of  Difference  in  Water  Works  Franchises  (Amer.  City,  vol.  xii, 

Apr.,  1915,  pp.  318-320) 
Chamberlain,  Lawrence 

Water    Company    Bonds,     (In)     Principles    of    Bond    Investments, 

pp.  357-365  (New  York,  Henry  Holt  &  Co.,  1913) 
Chase,  H.  S. 

Depreciation  in  Water  Works  Accounts,  with  Reference  to  Uniform 

Reports   (Jour.  New  England  Water  Works  Assoc.,  vol.  xxiv,  June, 

1910,  pp.  305-331) 
Hodgkins,  Henry  C. 

Franchises  of  Public  Utilities  As  They  Were  and  As  They  Are  (Jour. 

of  Amer.  Water  Works  Assoc.,  vol.  vi,  pp.  739-758) 
Wolff,  Mark 

Interpretation  of  Water  Works  Accounts    (Jour,   of   Amer.   Water 

Works  Assoc.,  vol.  iii,  June,  1916,  pp.  529-556) 
Wright,  C.  W. 

The  Holyoke  Water  Case    (Quart.   Jour,  of  Econ.,  1903,   vol.  xvii, 

No.  2,  pp.  842-345) 

Water  Power  Company 

Adams,  A.  D. 

Electrical  Transmission  of  Water  Power   (New  York,  McGraw  Hill 
Book  Co.,  1906,  pp.  334) 


774  INVESTMENT  ANALYSIS 

Analysis  of  Merrill  Report  on  Water  Power    (Electrical   World,   vol. 

Ivxiii,  No.  1,  July,  1916,  pp.  10-12) 
Brown,  R.  G. 

The  Water  Power  Problem  in  the  United  States   (Yale  Law  Jour., 

vol.  xxiv,  No.  1,  Nov.,  1914,  pp.  12-34) 
Brown,  Rome  G. 

Water  Power,   Limitations  of   Federal   Control   of   Water    Powers, 

Argument  Before  National  Waterways  Commission  (U.  S.  Pub.  Doc. 

850,  1911,  May  27,  1912,  pp.  64,  Wash.  Gov.  Printg.  Office,  June,  1912) 
Byllesby,  Henry  Masison 

Securities  of  Water  Power  Companies  as  Investments  (Philadelphia, 

Univ.  of  Penn.,  1911,  pp.  59,  Third  Edition) 
Chamberlain,  Lawrence 

Water-Power  Companies,   (In)  The  Principles  of  Bond  Investments, 

pp.  357-365  (New  York,  Henry  Holt  &  Co.,  1911) 
Chappell,  Delos  A. 

The  Financing  and  Development  of  Hydro-Electric  Power  (Proceed- 
ings of  the  Second  Annual  Convention  of  the  Investment  Bankers' 

Association,  1913,  pp.  153) 
Fairlie,  J.  A. 

Water  Power — Public  Regulation  of  Water  Power   in   the  United 

States  and  Europe   (Ann  Arbor,  Mich.,  1912,  pp.  21,  Reprint  from 

Michigan  Law  Review,  vol.  ix,  No.  6,  1911) 
Huey,  A.  S. 

Commercialism   in   the   Central    Station    (Chicago,   1911,    Pamphlet 

Reprint) 
Leighton,  M.  O. 

The  Federal  Water  Power  Policy  (Engineers  News,  vol.  Ixviii,  No.  24, 

Dec.  12,  1913,  pp.  1089-1091) 
Lincoln,  P.  M. 

Relation  of  Plant  Size  to  Power  Cost    (Stone  and  Webster  Pub. 

Service  Jour.,  Dec.,  1913,  vol.  xiii,  pp.  413-425) 
Lyndon,  Lamar 

Development  and  Electrical  Distribution  of  Water  Power  (New  York, 

J.  Wiley  &  Sons,  1908,  pp.  317) 
Pierce,  Henry  Josehua 

Federal   Water   Power  Legislation   Before  National   Electric  Light 

Association  (Chicago,  May  24,  1916,  Wash.  Gov.  Printg.  Office,  1916, 

pp.  12) 
United  States  Bureau  of  Corporations 

Report  on  Water  Power  Development  in  United  States  (Wash.  Gov. 

Printg.  Office,  March  14,  1913) 


INDEX 


Accounts  Payable:  (See  also  work- 
ing capital)  ;  analysis  of,  69-70. 

Accumulation  Fund:  of  discount 
bonds,  163-165. 

Adjustment  Bonds:  description  of, 
675. 

Advisory  Function  of  Investment 
Banker :  Chapters  I  and  VI. 

Alter  Acquired  Property  Clause: 
111-113. 

American  Investments  in  Foreign 
Countries:  643-649;  669-671. 

America-  Procedure  Law:  for 
trustees,  26-27. 

American  Street  Railway  Associa- 
tion :  on  conso  iclation  of  street 
railways,  331 ;  expense  of  street 
railways,  355. 

American  Telephone  and  Tele- 
graph Company  Comparative  In- 
come Statement :  Appendix  C. 

Amortization :  ( See  also  Bonds, 
Yields  and  Mathematics)  ;  of 
bonds,  161-163 ;  of  railway  equip- 
men  securities,  319-323 ;  of  farm 
mortgages  under  Federal  organi- 
zation, 523,  of  state  bonds  and 
municipal  bonds,  599-602. 

Analysis :  of  investments  essential 
characteristics,  5-7;  of  funda- 
mental ,  how  presented  in  this 
volume,  9 ;  of  corporation  report, 
51-94. 

Anticipation  Tax  Warrants:  (See 
Revenue  Bonds). 

Appraisal:  (See  also  Valuation); 
of  real  estate,  485;  of  farm 
lands.  512-514. 

Appreciation :  of  investments.  20- 
22;  as  distinct  from  amortiza- 
tion, 161-163 ;  of  land,  485-487. 

Assented  Bonds :  description  of, 
675. 

Assessed  Valuation:  (See  also 
Valuation)  ;  as  basis  of  tax,  218- 
219;  of  valuation  in  civil  divi- 
sions, 564-568. 

Assumed    Bonds :    description    of, 


675 ;  of  public  utility  by  munici 
pality,  586. 

Association  of  Life  Insurance 
Presidents :  report  on  farm 
mortgages,  510-511. 

Assignment:  of  stock,  131-134;  of 
registered  bonds,  142;  of  bonds, 
144. 

Attorneys  for  Bond  Houses :  gen- 
eral references,  Chapters  VI- 
VII. 

Balance  Sheet :  analysis  of,  58-76 ; 
of  railroads,  Chapter  XVI,  293 
seq. ;  of  timber  corporations, 
479-480. 

Banks :  investments  of,  25-26 ;  in 
relation  to  cycle,  189-191 ;  condi- 
tion of  in  relation  to  security 
market,  Chapters  X-XI,  168  et 
seq. 

Bank  Clearings:  relation  to  secu- 
rity prices,  178-179. 

Bank  Debits  of  Federal  Reserve: 
relation  to  security  prices,  179. 

Bank  Deposits  and  Reserves :  ef- 
fect on  security  prices,  174-178. 

Banker  :  as  underwriters.  95-109 ; 
as  syndicate  underwriter,  101- 
105;  market  support,  103-104; 
relation  to  reorganization,  127- 
130. 

Bibliography:  general  on  invest- 
ments, Appendix  B,  703-774. 

Blanket  Mortgages ;  description  of, 
675. 

Blue-Sky  Laws,  206-210. 

Bills  Payable  in  Corporation  Re- 
port: (See  Working  Capital.) 

Bills  and  Notes  Payable  in  Cor- 
poration Report,  70. 

Bills  Receivable  in  Corporation 
Report:  (See  Working  Capital). 

Bonds:  (See  individual  headings 
for  particular  corporations)  ;  de- 
scription of  all  classes  in  alpha 
betical  order.  Appendix  A,  697- 
774;  long  term  and  interest 
rates,  15;  hypothecation  of,  15- 


775 


776 


INDEX 


16;  prices  of,  19-20;  as  invest- 
ments, 32-34 ;  definition,  35  ;  gen- 
eral characteristics,  35-36;  the 
four  large  classifications  of,  39 ; 
classification  according  to  meth- 
ods of  payment  aud  redemption, 
46;  in  corporation  balance  cheet, 
72-73 ;  negotiation  and  issuance 
of,  95-109;  authorization  of 
issue,  96-98;  investigation  of  is- 
sue, 98-100;  sold  on  exchange, 
103-104 ;  engraving  rules  of  ex- 
change, 109 ;  mortgage  underly- 
ing, 110-130 ;  limitation  of  issue, 
111-113 ;  recital  in  mortgage, 
Chapter  VII,  110  et  seq. ;  mort- 
gage requirements,  113-117 ; 
properties  security,  117-120 ; 
functions  of  trustees  to,  120-123 ; 
position  of  in  foreclosure,  123- 
127 ;  relation  to  reorganization, 
127-130 ;  as  negotiable  instru- 
ments, 141-142  ;  registered,  142  ; 
transfer  and  assignment,  144- 
145 ;  coupons,  145-146 ;  validity 
and  legality  of,  147-150 ;  interest 
rates  and  yield,  151-167 ;  net 
yields  unrecorded  price,  157 ; 
price  where  net  yield  not  in  bond 
table,  158 ;  price  and  bank  dis- 
count, 158-159 ;  discount  and 
bond  price,  158-159;  book  value 
of,  160-161;  book  value  of  pre- 
mium bonds,  161-163;  accumula- 
tion funds  of  discount  bonds, 
163-165;  price  of  purchased  on 
other  than  interest  date,  165- 
166 ;  serial  schedule  of  price, 
166-167 ;  regulation  of  issuance, 
Chapter  XII,  198  et  seq.;  taxa- 
tion of,  Chapter  XIII,  218  et 
seq. ;  Public  Utility  commission 
control,  211-217;  taxation,  221; 
effect  of  inheritance  tax,  228- 
230 ;  exemption  from  taxation, 
235-241 ;  general  characteristics 
of  street  railway,  367-368;  char- 
acteristics of  hydro-electric,  423- 
424 ;  characteristics  water  com- 
pany, 434 ;  real  estate  mortgage, 
497-498 ;  debenture  mortgage 
bonds  on  real  estate,  498-501 ; 
leasehold  mortgage,  501-502  ;  spe- 
cial assessment  character  of,  572- 
575 ;  issuance  of  civil  bonds,  575- 
581 ;  duration  of  civil  obligations, 
597-598 ;  certification  of  civil  ob- 


ligations, 609-613 ;  tax  exemp- 
tion of  civil  obligation,  618- 
619. 

Bond  Attorneys :  in  advisory  ca- 
pacity in  Chapters  VI-VII. 

Bond  Houses  :  ( See  Banks,  Bankers 
and  Investment  Bankers)  ;  rela- 
tion to  source  city  banks,  104- 
105. 

Bond  Prices:  (See  Prices);  mar- 
ket influences,  Chapter  X-XI, 
168  et  seq. ;  influence  of  interest 
and  discount  rates,  170-174 ;  ef- 
fect of  loans,  deposits  and  re- 
serves on,  174-178 ;  effect  of  gold 
movements,  179-180 ;  effect  of 
seasonal  movements,  186-188 ; 
effect  of  business  cycle,  188-191 ; 
fluctuation  in,  191-193;  rise  and 
fall  as  related  to  yields,  193-197. 

Bond  Tables :  use  of,  153-156. 

Bonus  Bonds :  description  of,  675. 

Book  Value:  of  stock,  74-75;  of 
premium  bonds,  161-163;  of 
bonds,  160-161;  of  discount 
bonds,  163-165. 

Bridge  Bonds :  description  of,  675. 

British  Consols:  (See  Foreign 
Government  Bonds). 

Buildings:  effect  of  structural 
values,  487-490 ;  depreciation  of, 
490-491 ;  demand  of  locality,  491 ; 
cost  of  operating,  491-492. 

Business  Barometers :  general  dis- 
cussion applies  in  Chapters  X- 
XI,  168  et  seq. 

Business  Cycles  :  general  169-170 ; 
effect  on  security  prices,  188-191. 

Callable  Bonds :  description  of, 
676. 

Call  Loans  and  Call  Loan  Rate: 
general,  170  et  seq. 

Canadian  Municipal  Bonds  Certifi- 
cation, 611. 

Capital  Stock :  incorporation  bal- 
ance sheet,  73-74. 

Capitalization  of  Public  Utilities: 
214-215 ;  of  railroads.  301-312  ;  of 
street  railways,  355-359 ;  of  elec- 
tric light  companies,  373-377 ;  of 
gas  companies,  400-402 ;  of 
hydro-electric  companies,  420- 
422 ;  of  water  companies,  430- 
432;  of  steamship  companies, 
449-450;  of  private  irrigation 
projects,  536-537;  of  industrial 
corporations,  459,  462-465. 


INDEX 


777 


Car  Hour :  of  street  railways,  351- 
352. 

Carload :  of  railroads,  256-258. 

Car  Mile:  of  street  railways,  351- 
352. 

Car  Trust  Bonds :  description  of, 
676;  of  railroads,  317. 

Car  Trust  Certificates  or  Notes : 
description  of,  676 ;  of  railroads, 
315-317. 

Carey  Act  Bonds :  irrigation  secu- 
rities, 529-530. 

Certificates  of  Beneficial  Interest : 
description  of,  676. 

Certificate  of  Indebtedness:  de- 
scription of,  676-677. 

Certification  :  of  genuineness,  19 ; 
of  security  certificate,  29;  of 
corporation  report  by  auditor, 
51-54 ;  -f  civil  loans,  150  ;  of  civil 
loan  issues,  210-211;  of  civil  ob- 
ligations, 609-613. 

Circulation  Privilege  of  National 
Banks :  secured  by  United  States 
bonds,  637-638. 

City  or  Town  Bonds:  description 
of,  677. 

City  Bonds :  general  treatment  of, 
Chapters  XXXIII-XXXVI,  549 
et  seq. ;  jurisdiction  and  func- 
tion of  finances,  550-554 ;  physi- 
cal resources  of  civil  division, 
554-556 ;  financial  resources  se- 
curing, 556-557 ;  other  resources 
securing,  557-560;  importance  of 
population,  560-562;  importance 
of  financial  history,  562-563; 
valuation  of  property  for  tax 
purposes,  564-568;  taxation  and 
the  tax  rate  of  city,  568-572;  le- 
gality and  validity  of,  575-581; 
the  funded  debt,  582-584;  float- 
ing debt,  585-586;  per  capita 
debt,  587-589 ;  net  debt,  589-590 ; 
debt  restrictions,  590-597;  dura- 
tion of,  597-598;  method  of  pay- 
ing, 598-603 ;  repudiation  of,  603- 
605 ;  markets  of,  607-609 ;  certifi- 
cation of,  609-613;  denomination 
and  duration  of,  614-616;  tax 
exemption  of,  618-621. 

Civil  Loans  or  Obligations :  what 
they  include,  10 :  selling  of,  105- 
107;  legality  and  validity.  148; 
certification  of  issues,  210-211; 
jurisdiction  and  functions  of 
financing  by  civil  division, 


550-554 ;  Chapters  XXXIII- 
XXXVIII,  549-672;  physical  re- 
sources as  security,  554-556 ; 
financial  resources  securing,  556- 
557 ;  other  resources  securing, 
557-560;  importance  of  popula- 
tion, 560-562;  importance  of 
financial  history,  562-563;  valu- 
ation of  property  for  tax  pur- 
poses, 564-568 ;  taxation  and  the 
tax  rate  of  the  civil  unit,  568- 
572;  legality  and  validity  of, 
575-581;  the  funded  debt,  582- 
584;  ''oating  debt,  585-586;  per 
capita  debt,  587-589;  net  debt. 
589-590;  debt  restrictions,  590- 
597 ;  duration  of,  597-598 ;  meth- 
od of  paying.  598-603;  repudia- 
tion of,  603-605 ;  markets  of,  607- 
609;  certification  of,  609-613; 
purpose  of  issue  and  markets, 
613-614 ;  denomination  and  dura- 
tion of,  616-616;  tax  exemption 
of,  618-621. 

Classification :  of  bonus  general 
character  of,  37 ;  according  to 
character  of  obligor,  40-42 ;  ac- 
cording to  purpose  of  issue,  42- 
43;  according  *o  character  of 
lien,  43-46 ;  according  to  man- 
ner of  redemption  and  evidence 
of  ownership  and  transfer,  47- 
50;  of  mortgages,  111-113;  of 
equipment  securities.  314-317  ;  of 
Great  Lakes  Steamship  Bonds, 
448-449;  of  real  estate  bonds, 
497;  of  farm  securities,  511-512. 

Classified  Property:  for  taxation, 
222-224. 

Clearings  of  Banks :  relation  to 
prices  of  securities,  179. 

Closed  End  Mortgage :  defined,  112. 

Collateral  (see  also  Bonds,  Loans 
and  Liens)  ;  lending  on  listed 
securities,  30 ;  civil  loans  as  col- 
lateral, 616-618. 

Collateral  and  Participating 
Bonds:  ( See  Participating 
Bonds  &  Collateral  Bonds). 

Collateral  Income  Bonds :  descrip- 
tion of,  677. 

Collateral  Mortgage  Bonds :  de- 
scription of.  677. 

Collateral  Notes,  description  of, 
677. 

Collateral  Trust  Bonds,  descrip- 
tion, 677-678. 


778 


INDEX 


Common  Stock:  (See  Stocks). 

Commission  Regulation,  Chapter 
XII. 

Commissions :  of  banker,  103-105. 

Competition:  of  industrial  corpo- 
rations, 456-458 ;  hydro-electric 
companies,  411-413. 

Conditional  Sales  of  Railway 
Equipments :  ( See  Equipment 
Bonds). 

Consolidation  of  Street  Railways, 
330-332. 

Consolidated  and  First  Mortgages  : 
(See  Consolidated  Mortgage 
Bonds)  description  of,  678. 

Consolidating  and  Refunding  Mort- 
gage Bonds:  (See  Consolidated 
Bonds  ;  also  Refunding  Mortgage 
Bonds). 

Consolidated  Bonds:  (See  Con- 
solidated Mortgage  Bonds). 

Consolidated  Mortgage  Bonds :  de- 
scription of,  678-680. 

Constitutional  Restriction  of  Civil 
Debt,  590-597. 

Construction  Bonds :  description 
of,  680. 

Contingent  Debt  of  Cities,  etc. :  of 
civil  divisions,  585-586. 

Continued  Bonds  :  (See  Extension 
Bonds). 

Convertible  Bonds :  description  of, 
680-681. 

Convertible  Collateral  Trust 
Bonds :  ( See  Convertible  and 
Collateral  Trust  Bonds). 

Convertible  Debentures:  (See  De- 
benture Bonds). 

Convertible  Income  Bonds:  (See 
Income  Bonds). 

Convertibility :  need  and  rate  of 
return,  16;  of  real  estate  mort- 
gage, 494 ;  of  real  estate  bonds, 
504-505 ;  of  farm  mortgages,  515- 
516;  of  civil  bonds,  616-618. 

Corporation  Loans:  classifications 
of,  9 ;  affiliated  inter-company  re- 
lations, 54-57 ;  investigation  of 
bond  issue,  98-100. 

Corporation  Mortgage:  character 
of,  110-130;  provisions  of,  113- 
117. 

Corporation  Report:  analysis  of, 
51-94;  correctness  of,  59-60; 
railroad,  Chap  XVI,  293  et 
seq. ;  inadequate  street-railway 
reports,  343. 


Corporation  Securities :  distribu- 
tion of :  100-105. 

Costs  :  of  operating  street  railways, 
342-349 ;  of  operating  electric 
light  companies,  381-383;  of 
operating  gas  companies,  396- 
400 ;  of  constructing  hydro-elec- 
tric plants,  420-422;  of  con- 
structing telephone  and  tele- 
graph equipment,  439-443;  of 
operating  buildings,  491-492;  of 
irrigation  projects,  534-535 ;  of 
municipal  government,  606-607. 

Cost  of  Service  as  Basis  of  Rates, 
363-367. 

County  Bonds":  general  treatment 
of,  Chapters  XXXIII-XXXVI, 
549  et  seq. ;  jurisdiction  and 
function  of  finances,  550-554 ; 
physical  resources  of  civil  divi- 
sion, 554-556 ;  financial  resources 
securir  -,  556-557 ;  other  re- 
sources securing,  557-560 ;  im- 
portance of  population,  560-562 ; 
history,  562-563:  taxation  and 
the  tax  rate  of  the  county,  568- 
572 ;  valuation  of  property  for 
tax  purposes,  564-568;  impor- 
tance of  financial  legality  and 
validity,  575-581;  the  funded 
debt,  582-584 ;  floating  debt,  585- 
586;  per  capita  debt,  587-589; 
net  d  ot,  589-590;  debt  restric- 
tions, 590-597;  duration  of.  597- 
598;  method  of  paying,  598-603; 
repudiation  of,  603-605;  markets 
of,  607-609;  certification  of,  609- 
613 ;  denomination  and  duration 
of,  614-616;  tax  exemption  of, 
618-621. 

Coupons:  legal  character  of,  145- 
146. 

Coupon  Bonds:  description  of, 
682 ;  registration  and  transfer  of, 
142-143. 

Coupon  Notes :  description  of,  682. 

Credit:  as  affected  by  loans,  dis- 
counts and  reserves,  174-178 ;  as 
affected  by  general  conditiOLs, 
Chapters  X-XI,  168  et  seq.;  of 
governments,  632-635. 

Creditors  Claims,  117-120. 

Creditor  Nations:  650-656. 

Crises  and  the  Security  Market : 
general  references,  Chapters  X- 
XI,  168  et  seq. 


INDEX 


779 


Crops  and  Security  Markets,  184- 
1S5. 

Cumulative  Income  Bonds:  (See 
Income  Bonds). 

Currency  Bonds :  description  of, 
682. 

Current  Assets :  ( See  also  Work- 
ing Capital)  ;  analysis  of,  60-62; 
of  railroads,  300-301. 

Current  Liabilities:  (See  also 
Working  Capital)  ;  analysis  of, 
69-70. 

Cummings  and  Esche  Bill :  260- 
263 ;  266. 

Debentures :  (See  Debenture 
Bonds)  ;  description  of,  682. 

Debenture  Bonds:  liens  of,  119- 
120;  issue  of,  217;  description 
of,  682-683. 

Debenture  Income  Bonds  :  descrip- 
tion of,  683. 

Debenture  Mortgage  Bonds:  (See 
Debenture  Mortgages)  ;  on  real 
estate,  498-501. 

Debenture  Mortgages:  description 
of,  683. 

Debts:  secured  by  taxation,  223; 
of  the  civil  division,  Chapters 
XXXV,  582  et  seq. ;  funded  debt 
of  civil  divisions,  582-584;  mis- 
cellaneous debts  of  civil  divi- 
sions, 585-586;  per  capacity  of 
civil  divisions,  587-589 ;  net  debt 
of  civil  divisions,  589-590 ;  legis- 
tion  and  judicial  restrictions, 
590-597;  duration  of  civil  debt, 
597-598;  method  in  payment  of 
civil  debt,  598-603 ;  of  the  United 
States,  Chapter  XXXVII,  622  et 
seq. ;  repudiation  of  civil,  603- 
605;  forms  of  foreign  indebted- 
ness, 656-663. 

Debtor  Nations :  What  determines, 
650-656. 

Defalcation:  (See  Repudiation  of 
Debts). 

Deferred  Accounts :  in  corporate 
report,  63. 

Deferred  Bonds:  description  of, 
683. 

Delinquent  Tax  Certificates :  de- 
scription of,  683. 

Demand  Loans :  general,  170. 

Denominations:  (See  topic  at  end 
of  each  chapter — general  charac- 
teristics; of  civil  obligations, 


614-616 ;  of  United  States  Bonds, 
638-641. 

Density  of  Traffic:  of  street  rail- 
ways, 335-337 ;  on  railroads,  254- 
258. 

Deposits  in  Bank :  effect  on  secu- 
rity prices,  174-178. 

Depreciation:  of  buildings,  490- 
491 ;  in  corporation  report,  64- 
66 ;  reserves  for,  71-72 ;  of  equip- 
ment, 252 ;  of  railroad  equip- 
ment, 322-323;  of  street  rail- 
ways, 348,  359-361;  of  electric 
light  companies,  377-378;  of  gas 
companies,  402-403;  of  water 
companies,  429 ;  of  telephone 
and  telegraph  companies,  443- 
444 ;  of  industrial  corporations, 
460-461. 

Development  Mortgage :  descrip- 
tion of,  683. 

Discounts :  use  of,  61 ;  in  price  of 
bond,  163-165 ;  influence  on  bond 
prices,  170-174. 

Distribution:  of  investments  (See 
also  Diversification)  ;  of  civil  ob- 
ligation, 607-609. 

Diversification :  of  ii  vestments, 
22-24  ;  geographical  24 ;  in  time, 
24. 

Dividend  Policies,  85-88. 

Dividend  Sharing  Bonds:  (See 
Participating  Bonds). 

Divisional  (or  Division)  Bonds: 
description  of,  683-684. 

Dock  Bonds:  (See  Wharf  Bonds). 

Drainage  Bonds :  Chapter  XXXII, 
539  et  seq. ;  development  and 
history  of,  539-541 ;  organization 
of  districts.  541-542 ;  security  of, 
543-544 ;  taxes  in  districts,  544- 
546 ;  market  of,  546 ;  description 
of,  684. 

Drawn  Bonds:  (See  Callable 
Bonds). 

Duration:  (See  Bonds  also  gen- 
eral summation  at  end  of  each 
chapter)  ;  of  railroad  bonds, 
319-320;  of  debt  of  civil  divi- 
sions, 597-598;  of  civil  obliga- 
tions, 614-616. 

Earnings :  statement  of  American 
Telephone  and  Telegraph,  Ap- 
pendix C ;  of  gas  companies,  396- 
400;  relation  to  population,  92- 
93 ;  of  electric  light  companies, 
378-381;  of  hydro-electric  coir 


780 


INDEX 


panics,  422-423;  of  water  com- 
panies, 430-432;  of  industrial 
corporations,  465-467. 

Electric  Light  ar  1  Power  Bonds, 
Chapter  XX,  36^>  et  seq. 

Electric  Light  Companies :  devel- 
opment of,  369-371 ;  population, 
physical  factors,  and  territory 
served,  372-373;  property  ac- 
count, 373-377 ;  capitalization  of, 
373-377;  capital,  373-377;  earn- 
ings, 378-381;  costs  and  peak 
load,  381-383;  rates  charged, 
384-385 ;  franchises,  385-386 ; 
market  of  securities,  387 ;  rates 
(See  Rates). 

Equal  Installment  Bonds :  descrip- 
tion, 684. 

Equipment:  of  water  companies, 
428-429. 

Equipment  Bonds :  of  railroads, 
317;  description  of,  684. 

Equipment  Securities:  of  rail- 
roads, 250-253 ;  maintenance  of 
railroad,  289-291 ;  Chapter  XVII, 
313  et  seq.;  origin  of,  313-314; 
the  trust  deed,  318-319 ;  physical 
factors,  320-322;  depreciation  of 
equipment,  322-323 ;  maintenance 
and  renewals  of  railroad  equip- 
ment, 323-324;  investment  posi- 
tion, 325-327;  maintenance  of 
railroad  equipment,  325. 

Equity:  in  property,    (See  Liens). 

Estate  Tax,  228-230. 

European  Farm  Mortgages,  517- 
518. 

Exchanges:  (See  Stock  Exchange 
and  Listing  on  Exchanges). 

Exemption  from  Taxation:  gen- 
eral, 235-241;  of  civil  obliga- 
tions, 618-621;  of  United  States 
Bonds,  638-641. 

Expenditures  of  Railroads,  Chap- 
ter XV. 

Expenses :  operating  of  railroads, 
273-277;  operating  electric  light 
companies,  381-383;  of  hydro- 
electric companies,  422-423;  of 
telegraph  and  telephone  com- 
panies, 439-443;  of  industrial 
corporations,  465-467;  of  operat- 
ing building,  491-492. 

Express  Company  Bonds :  descrip- 
tion of,  684. 

Extended  Bonds:  description  of, 
684. 


Extension  Bonds,  description  of, 
684. 

Fair  Cash  Value  of  Property :  (See 
Valuation). 

Fair  Value  of  Property:  (See 
Valuation) . 

Farm  Loan  Associations  :  519-525 ; 
restrictions  and  security  loans, 
521 ;  description  of  issuance,  517- 
525. 

Farm  Mortgage  Bankers'  Associa- 
tion, 525. 

Farm  Mortgages :  and  Federal 
farm  loans,  Chapter  XXX,  507 
et  seq. ;  history  and  development 
of,  507-508;  increase  in  land 
values,  508-509 ;  geographical 
distribution  of  land,  509-511; 
classification  of,  511-512 ;  physi- 
cal appraisal,  512-514 ;  margin 
of  loans,  514-515 ;  convertibil- 
ity and  hypothecation,  515-516; 
period  of  redemption  after  fore- 
closure, 516-517 ;  issued  under 
Federal  Farm  Loan  Organiza- 
tion, 519-525. 

Farm  Mortgage  Bonds  :  description 
of,  6S4-6S5. 

Federal  Bank  System :  change  in 
reserves  and  effect  on  security 
market,  176-178. 

Federal  Bonds  :  ( See  United  States 
Bonds)  ;  selling  of,  105-107;  ex- 
emption from  taxation,  235-236 ; 
Chapter  XXXVII,  622  et  seq. 

Federal  Electric  Railway  Commis- 
sion :  on  regulation,  364-366. 

Federal  Estate  Tax:  (See  also 
Taxation),  character  of,  230. 

Federal  Farm  Loans :  footnote, 
105 ;  exemption  from  taxation, 
236 ;  and  farm  mortgages,  Chap- 
ter XXX,  507  et  seq. 

Federal  Farm  Loan  Board,  519- 
525. 

Federal  Income  Tax,  225-226. 

Federal  Land  Banks,  519-525. 

Federal  Reserve  Bank  Notes :  se- 
cured by  United  States  bonds. 
637-638. 

Federal  Regulations  of  Railroads, 
259-266;  Transportation  Act  of 
1920,  263-266. 

Federal  Stock  Transfer  Tax,  231. 

Federal  Taxes  :   (See  Taxation). 

Ferry  Bonds:  description  of,  685. 


INDEX 


781 


Fiduciary  Investments :  ( See  Trus- 
tee). 

Financial  Resources  of  Civil  Divi- 
sions:  556-557. 

Fire  Risks:  of  timber  lands,  476- 
478. 

First  and  Consolidated  Mortgages : 
description  of,  685. 

First  and  General  Mortgage 
Bonds:  description  of,  685. 

First  and  Refunding  Mortgage 
Bonds :  description  of,  685. 

First  Consolidated  Mortgage 
Bonds :  description  of,  685. 

First  General  Mortgage  Bonds: 
description  of,  685. 

First  Mortgage  Bonds :  description 
of,  685. 

First  Liens :  description  of,  685. 

First  Lien  and  General  Mortgage 
Bonds :  description  of,  685. 

First  Mortgages :  ( See  Mortgages, 
First  Mortgage  Bonds  and  Sec- 
ond Mortgages). 

First  Mortgage  Trust  Bonds:  de- 
scription of,  686. 

First  Refunding  Mortgage  Bonds: 
description  of,  686. 

First  Trust  Mortgages:  descrip- 
tion of,  686. 

First  Unifying  Mortgage  Bonds: 
(See  First  Consolidated  Mort- 
gage Bonds). 

Firsts:  (See  First  Mortgage 
Bonds) . 

Fixed  Assets :  in  corporation  re- 
port, 63-66;  of  railroads,  296- 
300 ;  of  street  railways,  355-359 ; 
of  electric  light  companies,  373- 
377 ;  of  gas  companies,  400-402 ; 
of  water  companies,  428-429 ;  of 
telephone  and  telegraph  com- 
panies, 439-443;  of  Great  Lake 
Steamship  companies,  449;  of 
industrials,  459-460. 

Fixed  Charges  (See  Interest)  : 
general,  84-85;  of  railroad,  311- 
312. 

Fixed  Liabilities  of  Corporation, 
72-76. 

Fixed  Property  Accounts,  63-66; 
(See  also  Fixed  Assets). 

Flat  Price:  (See  Bond  Prices  and 
Prices). 

Floating  Debt :  ( See  Corporation 
Report  Analysis). 


Floating  Debt  of  Civil  Division, 
585-586. 

Florida  East  Coast  Railway :  mort- 
gage map  and  key,  306-307. 

Founders  Bonds  •  description  of, 
686. 

Foreclosures :  position  of  lien,  117- 
120;  rights,  etc.,  of  bondholders, 
123-217 ;  on  farm  mortgages,  re- 
demption of,  516-617. 

Foreign  Government  Bonds:  secu- 
rity of,  629-635;  wealth  and 
income,  635-637 ;  Chapter 
XXXVIII,  648  et  seq.;  impor- 
tance in  the  United  States,  648- 
649 ;  reasons  for  foreign  invest- 
ments, 650-652;  effect  of  money 
systems  on,  625-656;  forms  of 
debts,  656-663;  method  of  pay- 
ment, 656-659;  purpose  of  issue, 
662-667;  investment  trusts  for, 
667-669;  markets  in  the  United 
States,  669-671;  pricee  of,  671- 
672. 

Franchise:  (See  also  Regulation)  ; 
in  corporate  report,  67 ;  of  elec- 
tric light  companies,  385-386;  of 
gas  companies,  403-404  ;  of  water 
companies,  432-434. 

Freight  Traffic  of  Railroads,  253- 
254. 

Funding  Bonds :  description  of, 
686. 

Funding  and  Real  Estate  Mort- 
gage Bonds :  description  of,  686. 

Gas  Company  Bonds:  (See  Chap- 
ter on  Gas  Bonds)  ;  Chapter 
XXI,  388  et  seq.;  history  and 
development  of,  388-391;  indus- 
trial uses  and  by-products,  391- 
393 ;  population  and  its  relation 
to  service,  393-395 ;  rates  of,  395- 
396 ;  earnings  and  cost  of  pro- 
duction, 396-400;  technical  meas- 
urements, 397-399;  capital  and 
capitalization  of,  400-402;  de- 
predation of,  402-403 ;  franchises 
of,  403-404 ;  general  characteris- 
tics of  bonds,  405-406. 

Gas  Rates:  (See  Rates). 

General  First  Mortgage  Bonus : 
description  of,  686. 

General  and  First  Mortgage 
Bonds:  (See  General  First 
Mortgage  Bonds). 

General  Mortgage  Bonds:  descrip- 
tion of,  686. 


782 


INDEX 


Georgia  Acts  Regulating  Securi- 
ties :  issues,  footnote,  211. 

Geographical  Distribution  of  Farm 
Mortgages:  purchases  by  issu- 
ance companies,  509-511. 

Gold  Bonds :  description  of,  686- 
687. 

Gold  Imports  and  Exports:  effect 
on  security  pieces,  179-180. 

Goodwill :  in  corporate  report,  66- 
67;  of  industrial  corporations, 
461-462. 

Government  Bonds:  (See  United 
States  Bends  and  Foreign  Gov- 
ernment Bonds)  ;  bonds,  interest 
rates,  15;  United  States  selling 
of,  105-107;  Chapters  XXXVII 
and  XXXVIII,  622  et  seq. ;  se- 
curity of,  629-635;  foreign  in- 
vestment trusts,  667-669. 

Government  Ownership  of  Tele- 
phone and  Telegraph,  435-437. 

Great  Lakes  Steamship  Bonds: 
Chapter  XXV,  447  et  seq.;  his- 
tory and  development  of,  447- 
448;  classification  of,  448-449; 
physical  properties,  449 ;  finan- 
cial status,  449-450;  trust  deed 
of,  450-452 ;  insurance  of,  452- 
453;  Michigan  and  Ohio  laws, 
453-454 ;  characteristics  of,  454. 

Gross  Earnings:  (Details  of  Earn- 
ings for  ea.h  type  of  corpora- 
tion appears  under  heading  of 
the  particular  corporation)  ; 
sales  and  analysis  of,  78-81. 

Guaranteed  Bonds :  by  municipal- 
ities and  counties,  etc.,  586 ;  de- 
scription of,  687. 

Guarantee  of  Safety  in  listing  on 
Stock  Exchange,  28-29. 

Hadley  Railroad  Security  Com- 
mission, 204-205. 

History :  origin  ai.d  development 
of  equipment  securities,  313-314  ; 
of  street  railways.  328-330;  de- 
velopment of  electric  lifht  and 
power  bonds,  369-372 ;  gas  com- 
pany bonds,  388-391;  of  hydro- 
electric power  companies,  407- 
409 ;  of  private  water  companies, 
425 ;  of  development  of  telephone 
and  telegraph  companies.  435- 
437;  of  Great  Lakes  Steamship 
bonds,  447-449 ;  of  development 
of  timber  bonds,  469 ;  of  develop- 
ment of  farm  mortgages,  507- 


509 ;  of  develpoment  of  irrig,i 
tion  bonds,  526-527;  of  civil  di- 
vision and  its  integrity,  562-563 ; 
of  development  of  drainage 
bonds,  539-541 ;  of  United  States 
bonds,  622-629. 

Holding  Companies :  relationship 
to  corporate  organization,  57-61. 

Hydro-Electric  Power  Bonds: 
Chapter  XXII,  407  et  seq.;  de- 
velopment of,  407-409 ;  character 
of  business  and  markets,  409- 
411 ;  competition  of,  411-413 ;  wa- 
ter supply  storage  and  pondage, 
413-416 ;  riparian  rights,  416- 
418 ;  regulation  of  water  supply, 
418-420;  cost  of  construction, 
420-422 ;  earnings  and  operation 
costs,  422-423 ;  general  bond 
characteristics,  423-424. 

Hypothecation :  of  securities,  30 ; 
of  real  estate  mortgages,  494 ;  of 
farm  mortgages.  515-516 ;  of 
Civil  loans,  616-618. 

Illegality:   (See  Invalidity). 

Improvement  Bonds :  description 
of,  687. 

Incidence  of  Taxation  of  Securi- 
ties, 234-235. 

Income:  safety  of,  13-14;  rates  of, 
14-15  ;  accounts  of  railroads,  267- 
268 ;  other  income  of  railroads, 
2S7-288;  net  corporate  of  rail- 
roads, 288-291;  other  income  of 
street  railways,  346 ;  of  street 
railways,  342-349;  of  electric 
light  companies.  378-281 ;  of  gas 
companies,  396-400;  of  hydro- 
electric companies,  422-423 ;  of 
water  companies,  430-432;  of 
telegraph  and  telephone  com- 
panies, 439-443 ;  of  industrial 
corporations,  465-467 ;  of  the 
United  States,  635-637. 

Income  Bonds:  (See  Debenture 
Income  Bonds  which  is  complete 
title)  description  of,  688. 

Income  Statements  :  general  analy- 
sis, 76-94 ;  character  of,  77-78 : 
of  railways.  344-345 ;  of  electric 
light  companies,  379  ;  of  gas  com- 
panies, footnote  396 ;  of  water 
companies,  430-432 ;  of  timber 
corporations,  479-480. 

Income  Tax :  general,  225-228. 

Indorsed  Bonds :  description  of, 
688. 


INDEX 


783 


Industrial  Boiids :  Chapter  XXVI, 
445  et  seq. ;  character  and  size 
of  business,  455-456;  competition 
of,  456-458 ;  management  of  cor- 
poration, 458-459;  fixed  proper- 
ty accounts  of,  459-460 ;  depre- 
ciation of,  460-461 ;  maintenance 
of,  461;  goodwill  of,  461-462; 
working  capital  of,  462-465 ; 
sales,  earnings  and  expenses  of, 
465-467  ;  legal  status  of,  467-468 ; 
market  of,  468. 

Industrial  Uses  of  Gas,  391-393. 

Inheritance  Taxation,  228-230. 

Installment  Bonds:  description  of, 
688. 

Installment  Plan  in  Purchase  of 
Real  Estate  Bonds,  502-503. 

Insurance :  of  property,  69 ;  of 
Great  Lakes  Steamship  com- 
panies, 452-453 ;  of  timber  lands, 
476-478. 

Insurance  Companies :  distribution 
of  farm  mortgages  purchased, 
509-511. 

Interest  Rates:  changing,  15;  and 
price  of  bonds,  19-20 ;  in  default, 
125-126;  net  yield  on  bonds, 
Chapter  IX,  151  et  seq;  how  to 
determine  net  yield,  152-153 ; 
influence  on  security  prices,  170- 
174 ;  effect  of  business  cycle,  189- 
190;  charges  of  railroads,  289- 
290;  on  farm  mortgages  issue 
under  Federal  organization,  523 ; 
on  United  States  Bonds,  638- 
641. 

Intercepting  Sewer  or  Improve- 
ment Bonds :  description  of,  688. 

Interchangeable  Bonds :  descrip- 
tion of,  688. 

Interim  Certificates :  description 
of,  688. 

Interstate  Commerce  Commission, 
259-263. 

Interstate  Commerce  Act  of  1887, 
260. 

Interurbans :  (See  Items  Under 
Street  railways,  Chapters 
XVIII-XIX,  328  et  seq.;  special 
problems  of  337-342;  character 
of  traflic,  339-340,  342;  location 
of,  338-339:  terminals  of.  341; 
technical  units  of  measurements, 
350-355. 

Interminable  Loans:  (See  Perpe- 
tual Bonds). 


Internal  Loans  vs.  External  Loans, 
630-631,  648-649. 

Inventories:  (See  Current  Assets 
and  Working  Capital). 

Investigation  for  Basis  of  Pro- 
posed Issues,  98-100. 

Investments :  meaning  of,  Chapter 
I,  3  et  seq. ;  meaning  of,  3-11 ; 
necessity  for  more  careful  study 
of,  4-5 ;  what  the  field  includes, 
7-8 ;  of  life  insurance  companies, 
27-28;  of  commercial  banks,  28; 
classification  of,  Chapter  III,  32 
et  seq. ;  what  is  included  und«»  , 
32-36;  definition  of,  33-34;  of 
corporation  in  securities,  67-69 ; 
on  corporate  report,  67-69. 

Investment  Banker :  advisory  ca- 
pacity, etc. ;  Chapters  I,  3-12, 
and  VI,  95-110. 

Investment  Trusts:  for  foreign 
bonds,  667-669. 

Investment  vs.  Speculation:  Chap- 
ter I,  3  et  seq. 

Invalidity  :  ( See  Illegality,  Legal- 
ity and  Validity). 

Irredeemable  Bonds :  description 
of,  688. 

Irrigation  Securities :  Chapter 
XXXI,  526  et  seq. ;  development 
of  Federal  legislation,  526-527; 
municipal  irrigation  district 
bonds,  527-529 ;  Carey  Act  bonds, 
529-530 ;  private  corporation 
bonds,  530-531;  security  of,  531- 
532;  water  supply  for,  532-533; 
title  to  land,  533-534 ;  cost  of  pro- 
jects, 534-535 ;  capitalization  of 
private  projects,  536-537;  work- 
ing capital  of  settlers,  537-538; 
market  of,  538. 

Issuance  of  Bonds:  Chapter  VI, 
and  negotiation  of  bond  issues, 
95-109;  of  railroad  equipment, 
325 ;  authority  of  issuing  civil 
bonds,  575-581. 

Issuing  Political  Unit  and  the  Se- 
curity of  its  Bond  Issues :  Chap- 
ter XXXIII,  549  et  seq. 

Jitney :  competition  with  street 
railways,  365-366. 

Joint  Account  in   Syndicates,  102. 

Joint  Bonds :  description  of,  689. 

Joint  Collateral  Trust  Bonds :  (See 
Joint  Bonds). 

Joint  Mortgages:  (See  Joint 
Bonds). 


784 


INDEX 


Joint  Stock  Lan<l  Bankers,  519- 
525. 

Judgment  Bonds:  description  of, 
689. 

Junior  Mortgages:  description  of, 
689. 

Jurisdiction  and  Function  cf  Civil 
Divisions,  550-554. 

Land  Grant  Bonds :  description  of, 
689. 

Land  Grant  Certificates:  (See 
Land  Grant  Bonds) . 

Land  Titles:  in  irrigation  pro- 
jects: 533-534. 

Land  Values:  increase  in  farm 
land  values,  508-509. 

Leasehold  Mortgage  Bonds :  501- 
502;  description  of,  689. 

Legal  Debt:   (See  Debt). 

Legal  Investments:  of  savings 
banks,  25-26;  of  trustees,  26-27; 
of  life  insurance  companies, 
27-28. 

Legal  Prerequisites  of  Timber 
Bonds,  472-476. 

Legal  Status:  of  industrial  cor- 
porations, 467-468. 

Legal  Tender  Bonds:  description 
of,  689. 

Legality:  (See  also  Validity);  of 
investment,  17-19;  and  listing, 
108;  of  bonds,  147-150;  of  civil 
bonds,  575-581. 

Levee  Bonds:  Chapter  XXXII, 
529  et  seq. ;  security  of,  543-544  ; 
taxes  in  district,  544-546;  mar- 
ket of,  546;  description  of,  689. 

Liabilities :  analysis  of  the  balance 
sheet,  69-76. 

Liberty  Bonds:  (See  Government 
Bonds)  ;  selling  of,  105-107 ; 
Chapter  XXXVII,  622  et  seq.; 
exemption  from  taxes,  235-236 ; 
table  of  all  characteristics,  Ap- 
pendix B. 

Lien:  (See  also  Mortgages); 
priority  of,  38-39 ;  upon  proper- 
ty, classification  of,  45-46;  char- 
acter of,  57-58 ;  priorities  in,  117- 
120. 

Life  Insurance  Investments,  27-28. 

Limit  of  Civil  Debt,  590-597. 

Listed  vs.  Unlisted  Securities;  28- 
30;  107-109. 

Listing :  of  securities  on  stock  ex- 
change, 28-31 ;  advantages  of, 
107 ;  on  stock  exchange,  107-109 ; 


legality  evidence,  108;  of  civil 
obligations,  607. 

Loans:  (See  Bonds  and  Notes); 
unlisted  securities,  30;  effect  on 
security  prices,  174-178;  ratio  to 
deposits,  174 ;  margin  of  loans  on 
mortgages,  493 ;  margin  on  farm 
mortgages,  514-515;  of  the  Fed- 
eral Land  Bank,  519-525 ;  on  col- 
lateral of  civil  loans,  616-618. 

Location :  effect  of  railroads,  245- 
250;  street  railways,  332-334; 
electric  light  companies,  373- 
374;  gas  companies,  390-391; 
hydro-electric  companies,  409- 
411. 

Location  and  Distribution  of  Farm 
Mortgages:  509-511. 

Lost  or  Destroyed  Securities,  140. 

Low  Rate  Plan  of  Taxation:  222- 
224. 

Maintenance  of  Way  :  of  railroads, 
277-2SO;  of  equipment  of  rail- 
roads, 280-281;  of  railroad 
equipment,  323-324 ;  of  telegraph 
and  telephone  companies,  443- 
444 ;  o*  industrial  corporations, 
461. 

Management :  of  corporation,  55 ; 
of  industrial  corporations,  458- 
459. 

Manipulation  of  Security  Prices, 
104. 

Markets:  stability  of  price,  19-20; 
value  of  securities,  22 ;  for  se- 
curities supported  by  banks,  30- 
31 ;  supported  by  banker,  103- 
104 ;  creating,  106 ;  influences  on 
security  prices,  Chapters  X-XI, 
168  et  seq. ;  of  equipment  securi- 
ties, 325-327;  for  electric  light 
securities,  387;  of  gas  company 
bonds,  404-406;  of  hydro-electric 
bonds,  423-424;  of  water  com- 
pany bonds,  434;  of  telegraph 
and  telephone  companies'  bonds, 
446;  of  industrial  bonds,  468; 
for  timber  bonds,  480 ;  of  real 
estate  bonds,  506 ;  tor  irrigation 
securities,  538 ;  for  drainage  and 
levee  bonds,  546;  of  civil  obliga- 
tions, 607-609;  of  United  States 
bonds,  641-647;  American  mar- 
ket for  foreign  bonds,  669-671. 

Marketability:  (See  Convertibility 
and  Negotiability)  ;  of  invest- 
ment, 15-17. 


INDEX 


785 


Massachusetts  Income  '"ax.  227- 
228. 

Mathematics  of  Bonds:  Chapter 
IX,  15^  et  seq. 

Maturities:   (See  Duration). 

Michigan  Statutes :  governing 
steamship  bond  purchases  for 
savings  banks,  453-454. 

Mileage:  effect  on  railroad  earn- 
ings, 245-250. 

Mining  Bonds :  description  of,  689. 

Minnesota  Low  Rate  Plan  of  Tax, 
223-224. 

Money  System :  effect  on  national 
bond  values,  652-656. 

Mortgages:  as  investments,  32-34; 
rate  of  return  compared  with 
return  on  bonds,  34 ;  in  corpora- 
tion balance  sheet,  73;  listing 
rules,  109 ;  definition,  110 ;  closed 
end,  111-112 ;  classification  of, 
111-113 ;  corporation  provisions 
of,  113-117;  priorities,  117-120; 
function  of  trustee,  120-123 ;  po- 
sition of  in  foreclosure,  123-127 ; 
relation  to  reorganization,  127- 
130;  taxation  of,  221-229;  mar- 
gin of  loans  on  real  estate.  493 ; 
taxation  of,  493-494 ;  converti- 
bility and  hypothecation,  494 ; 
characteristics  of  real  estate 
mortgages,  494-495. 

Mortgage  Bonds :  description  of, 
689. 

Mortgage  Collateral  Trust  Bonds : 
(See  Collateral  Trust  Bonds). 

Mortgage  Debentures:  (See  De- 
benture Bonds) . 

Mortgage  Foreclosure.  117. 

Mortgage  Guaranty  Companies :  of 
real  estate  bonds.  500-501. 

Mortgage  Income  Bonds  :  descrip- 
tion of,  689. 

Mortgage  Maps  :  of  railroad,  304  et 
seq. 

Mortgage  Priority  and  Security : 
(See  Liens). 

Municipal  Bonds:  interest  rates, 
15;  authorization  of,  97-98;  sell- 
ing of,  105-107;  certification  of, 
150;  certification  of  issues,  210- 
211 ;  exemption  from  taxation, 
236-241 ;  general  treatment  sub- 
ject. Chapters  XXXIII-XXXVI, 
549  et  seq. ;  jurisdiction  and 
functions  of  finances  of  civil 
divisions,  550-554;  physical  re- 


sources of  civil  division,  554-556 ; 
financial  resources  securing,  556- 
557;  other  resources  securing, 
557-560;  importance  of  popula- 
tion, 560-562;  importance  of 
financial  history,  562-563;  valu- 
ation of  property  for  tax  pur- 
poses, 564-568;  taxation  and  the 
tax  rate  of  the  municipality,  568- 
572;  legality  and  validity  of, 
575-581;  the  funded  debt,  582- 
584;  floating  debt,  585-586;  as- 
sumption of  public  utility  debt, 
586;  per  capita  debt,  587-589; 
net  debt,  589-590;  debt  restric- 
tions, 59U-597;  duration  of,  597- 
598;  method  of  paying,  598-603; 
repudiation  of,  603-605;  cost  of 
municipal  governments,  606-607; 
markets  of,  607-609 ;  certification 
of,  609-613;  tax  exemption  of, 
618-621 ;  convertibility  of  and  use 
as  collateral,  616-618 ;  denomina- 
tions and  durations  of,  614-616. 

Municipal  Irrigation  Districts,  527- 
529. 

Municipal  Mortgage  Bonds:  de- 
scription of,  689-690. 

National  Bank  Notes:  secured  by 
United  States  bonds,  637-638. 

National  Bonds:  (See  Chapter  on 
Government  Bonds). 

National  Farm  Associations,  519- 
525. 

National  Taxation  Association : 
situs  of  holder,  232-234. 

Negotiable  Instruments :  charac- 
ter of,  141-142. 

Negotiation  of  Issuance  of  Bonds : 
Chapter  VI,  95  et  seq. 

Negotiability:  (See  Marketabil- 
ity). 

Net  Capitalization:  (See  Capitali- 
zation). 

Net  Corporate  Income  of  Rail- 
roads, 288-291. 

Net  Debt  of  Civil  Divisions,  589- 
590. 

Net  Income :  what  it  is,  81-83. 

Net  Operating  Revenue:  of  rail- 
roads, 285-286. 

Net  Sales :  determination  of,  81. 

Net  Yield  and  Interest  of  Rate  of 
Bonds:  Chapter  IX,  151  et  seq. 

New  York :  Savings  bank  law  and 
amortization,  160-161 ;  recording 
tax,  224-225;  income  tax,  228; 


786 


plan  of  issuing  equipment  secu- 
rities, 317. 

New  York  Stock  Exchange:    (See 
also  Listed  Stock)  ;  listing  rules, 
107-109. 
Nominal  Interest  Rate:   (See  Also 

Interest  Rate),  151-152. 
North     Dakota :     certification     of 

civil  debts,  611-612. 
Notes  :    .  as     investments,     32-34  ; 

description  of,  690. 
Notes   Receivable:    (See   Working 

Capital). 
Officials:   of  civil  division  selling 

bonds,  106-107. 

Ohio  Statutes:  regulating  pur- 
chase of  steamship  bonds  for 
savings  banks,  453-454. 
Operating  Costs :  of  street  rail- 
ways, 342-349;  of  electric  light 
companies,  381-383;  of  hydro- 
electric companies,  422-423 ;  of 
industrials,  465-467 ;  of  build- 
ings, 491-492. 

Operating  Expenses :  80-83 ;  rela- 
tion to  gross  earnings,  85 ;  of 
railroads,  273-277 ;  distribution 
of  street  railway,  346-347;  of 
telegraph  and  telephone  com- 
panies, 439-443. 

Operating  Income:    (See  Income). 
Operating    Net    Income:    general, 

81-83. 

Operating  Ratio :  character  of,  91- 
92;    of    railroads,    283-285;    of 
street  railways,  353. 
Operating    Revenues :     ( See    also 

Revenues). 
Optional    Bonds :    description    of, 

690. 
Organization :  of  corporation,  55 ; 

of  drainage  districts,  541-542. 
Other   Income:   what  it  includes, 

83-84. 

Other  Resources :  general,  as  secu- 
rity of  civil  obligations,  557-560. 
Over-Capitalization  :  effects  of,  74 ; 

of  public  utilities,  214-215. 
Overlying  Mortgages :    description 

of,  690. 
Overstrained  Market:   Results  of, 

189. 

Panics  and  the  Security  Market: 
general  references,  Chapters  X- 
XI,  168  et  seq. 

Participating  Bonds :  description 
of,  690. 


Passenger    Traffic:    of    railroads 

253-254. 
Paper  Money :   effect  on  national 

debt,  652-653;  659-661. 
Paving  Bonds:   (See  Improvement 
and  Special  Assessment  Bonds). 
Payment  of  Debt:  (See  also  Dura- 
tion,   Sinking   Fund   and    Serial 
Payments)  ;    of    civil    divisions, 
598-603;     national     debts,     656- 
663. 

Peak  Load :  of  electric  light  com- 
panies, 375-376;  of  electric  light 
companies,  381-383;  of  water 
companies,  432. 

Pennsylvania  Low  Rate  Tax,  223. 
Per     Capita     Income:     statistical 
measurement,     92-93 ;    measure- 
ment of  electric  light  companies, 
375-376;   debt  of  civil  divisions, 
587-589. 
Perpetual   Bonds:    description   of, 

690. 

Personal  Property :  as  a  basis  of 
valuation  and  taxation,  218-244; 
564-568. 
Philadelphia      Plan :      of     issuing 

equipment  securities,  315-317. 
Physical      Appraisal      of      Farm 

Lands:  512-514. 

Physical     Factors :     of     railroad 
equipment,   320-322;    of   electric 
light  companies,  372-373. 
Physical  Resources  or  Assets :  of 

civil  divisions,  554-556. 
Physical   Valuation  of  Railroads : 

(See  Valuation). 
Plain  Bonds :  description  of,  690. 
Pondage  of  Water :  of  hydro-elec- 
tric companies,  413-416. 
Population      Distribution :       and 
earnings,    93 ;    effect    on    street 
railway  traffic,  332-337;  electric 
light   companies,    372-373;    rela- 
tion to  gas  companies,  393-395 ; 
effect   on   water   company   secu- 
rities, 426 ;   in   relation  to  civil 
obligations,  560-562. 
Postal     Savings     Issues     of     the 

United  States,  628,  640. 
Preference    Income    Bonds:     (See 
Income  Bonds)  ;  description  of, 
690. 
Preferred  Stocks:  as  investments, 

33 ;  of  railroads,  302. 
Preferential    Bonds:     (See    Prior 
Lien  Bonds). 


INDEX 


787 


Premium  Bonds  :  price  of,  161-163 ; 
description  of,  690. 

Principles  of  Investments :  gen- 
eral, 12-31;  safety  of,  13-14; 
other  criteria,  24-31. 

Prior  Lien  Bonds:  description  of, 
691. 

Private  Irrigation  Corporation 
Bonds :  530-531. 

Prices:  of  bonds,  19-20;  of  listed 
and  unlisted  securities,  30-31 ; 
effect  of  manipulation  on,  104 ; 
of  securities  and  syndicate,  101- 
104;  calculating  net  prices,  115- 
167 ;  flat  price  of  bonds,  156 ;  of 
bonds  with  unrecorded  net  yield, 
158;  of  bond  and  bank  discount, 
158-159 ;  price  level,  its  effect  on 
prices,  172-173;  rising  and  fall- 
ing as  affecting  investment  yield, 
193-197  factors  affecting  civil 
bonds,  Chapter  XXXVI,  606  et 
seq. ;  and  purpose  of  civil  loans, 
613-614 ;  of  United  States  bonds, 
641-647;  of  Liberty  Bond  issues, 
645-647;  of  Foreign  government 
bonds,  671-672. 

Priority  of  Claims:  (See  Liens). 

Profit  Sharing  Bonds:  (See  Par- 
ticipating Bonds). 

Property  Account  and  Properties: 
of  railroads,  296-300;  of  street 
railways,  355-359;  of  electric 
light  companies,  373-377;  of  gas 
companies,  400-402 ;  of  water 
companies,  428-429;  of  telephone 
and  telegraph  companies,  439- 
443;  of  Great  Lake  Steamship 
Bonds,  449;  of  industrials,  459- 
460. 

Property  Values :  character  of  lien 
on.  57-58. 

Protection  of  Banker  to  Investor : 
in  advising  and  issuing  of  secu- 
rities, 3 ;  95-109. 

Publicity :  as  form  of  control  or  se- 
curity issues.  202-206. 

Public  Utilities :  state  regulation 
of,  211-217;  amount  of  bonds  in 
relation  to  capitalization,  213 ; 
recapitalization  in  reorganiza- 
tion, 214 ;  sale  of  securities  be- 
low par,  215 ;  consolidation  of, 
330-332 ;  advantages  of  large  or- 
ganization. 437-439. 

Public  Utility  Bonds:  Chapters 
XVIII-XXV,  328  etseq. 


Public  Utility  Regulations:  of 
Corporation,  363-367. 

Purchase  Line  Mortgages  :  descrip- 
tion of,  691. 

Purchase  Money  Bonds :  descrip- 
tion of,  691. 

Purpose  of  Civil  Debt  Issues  vs. 
Market  and  Price,  613-614. 

Purpose  of  Issue  of  Foreign  Gov- 
ernment Bonds,  662-663. 

Railroad  Aid  Bonds :  description 
of,  691. 

Railroad  Gross:  earnings  and  se- 
curity prices,  183. 

Railroad  Bonds :  physical  factors 
and  traffic  statistics,  Chapter 
XIV;  expenditures  and  rev 
enues,  Chapter  XV;  capital  ac- 
counts and  balance  sheet,  Chap- 
ter XVI ;  mile  unit  measure- 
ment, 90-91 ;  terminals  of  rail- 
road, 245-246;  location,  246-248; 
mileage,  249-250 ;  equipment, 
250-253;  passenger  and  freight 
traffic,  253-256;  traffic  density, 
254-256;  trainload  and  carload, 
256-257 ;  terminals,  258-259 ;  reg- 
ulation and  control,  259-266; 
Transportation  Act  of  1920,  263- 
266;  valuation  of,  263-277;  op- 
erating revenues,  269-273 ;  oper- 
ating expense,  273-277;  main- 
tenance of  way,  277-280;  main- 
tenance of  equipment,  280-281 ; 
transportation  expense,  211-283; 
operating  ratio,  283-285 ;  net  op- 
erating revenue  of,  285-286;  tax 
account,  286-287;  other  income, 
287-288 ;  net  corporate  income, 
288-291;  rental  charges.  289;  in- 
terest charges,  289-290;  dis- 
tribution of  surplus.  291-292; 
property  account.  296-300 ;  cur- 
rent accounts  of,  300-301 ;  lien  of, 
303;  liabilities  of,  301-312;  capi- 
talization. 301-312;  investments 
of,  310-311 ;  gross  capitalization 
deferred,  309;  fixed  charges  of, 
311-312. 

Railroad  Equipment  Securities : 
Chapter  XVII ;  car  trust  certifi- 
cate, 315-317 ;  equipment  bonds. 
317;  car  trust  bonds.  317;  trust 
deed  of  equipments,  318-319 ;  du- 
ration and  terms  of  payment. 
319-320;  physical  factors,  320- 
322;  depreciation  of  equipment, 


788 


INDEX 


322-323;  maintenance  and  re- 
newals of  equipment,  323-324,  in- 
surance of,  325. 

Railroad  Mortgage  Maps,  304-307. 

Railway  Trust  Bonds :  description 
of,  691. 

Rates:  of  street  railways,  361 
seq. ;  of  electric  light  com- 
panies, 384-385;  of  gas  com- 
panies, 395-396;  of  telegraph 
and  telephone  companies,  444- 
446. 

Rate  of  Interest:    (See  Interest). 

Real  Net  Debt  of  Cities :  (See  Net 
Debt  of  Cities). 

Real  Valuation  :  ( See  Valuation  of 
City  Property). 

Real  Estate  Bonds:  Chapter 
XXIX,  496  et  seq. ;  classification 
of,  497 ;  purchase  on  installment 
plan,  502-503;  trust  deed,  503- 
504;  convertibility  of,  504-505; 
market  of,  506  (See  Real  Estate 
Mortgage  Bonds). 

Real  Estate  Mortgages:  Chapter 
XXVIII,  483  et  seq.;  develop- 
ment of,  483-484;  appraising  of 
real  estate,  485 ;  appreciation  of 
land,  485-487;  margin  of  loans, 
493;  taxation  of,  493-494;  con- 
vertibility and  hypothecation 
of,  494 ;  characteristics  of,  494- 
495. 

Real  Estate  Mortgage  Bonds :  497- 
498;  description  of,  691-692. 

Real  Property :  basis  of  valuation 
for  taxes,  564-568. 

Real  Valuation:    (See  Valuation). 

Realty  Valuation:  (See  Valuation 
and  Real  Estate  Valuation). 

Receivers'  Certificate:  priority  of 
lien,  118-119 ;  description  of,  692. 

Receiverships :  general,  118-120 ; 
rights  under,  123-127. 

Reclamation  Bonds:  Chapter 
XXXI  and  XXXII,  526  et  seq.; 
description  of,  692. 

Recordation  Method  of  Taxation, 
222-224. 

Redemption  Bonds:  (See  Refund- 
ing Bonds). 

Redeemable  Bonds:  description  of, 
692. 

Redemption :  of  farm  mortgages 
after  foreclosure,  516-517. 

Refunding  Bonds:  description  of, 
G92-684. 


Refunding  Civil  Obligations,  615- 
616. 

Refunding  First  Mortgage  Bonds : 
description  of,  694. 

Registered  Bonds :  assignment  and 
transfer  of,  142 ;  description  of, 
694. 

Registered  Coupon  Bonds :  descrip- 
tion of,  694. 

Registration  of  Securities,  131-134. 

Regulation  of  Securities  Issues : 
Chapter  XII,  198  et  seq. ;  of  secu- 
rity issues  general,  198-202 ;  by 
publicity,  202-206;  by  Blue  Sky 
Laws,  206-210. 

Regulation  and  Control  of  Rail- 
roads, 259-266. 

Regulation  of  Street  Railways, 
363-367. 

Regulation  of  Water  Supply  of 
Hydro-electric  Companies,  418- 
420. 

Renewal  Bonds:  (See  Extension 
Bonds). 

Reorganization  Agreements  and 
Statutes  Regulating,  127-130. 

Repudiation  of  Civil  Debts:  gen- 
eral discussion,  603-605;  of  for- 
eign government  bonds,  6b3- 
667. 

Riparian  Rights  of  Hydro-electric 
Companies,  416-418. 

Reserves  of  a  Corporation,  70-72. 

Reserves  (bank)  :  effect  on  secu- 
rity prices,  174-178. 

Residuary  Estate  Bonds :  descrip- 
tion of,  694. 

Restrictions  on  Indebtedness  of 
Civil  Divisions.  590-597. 

Revaluation  of  Property  Accounts, 
79-80. 

Revenues :  of  Railroads,  Chapter 
XV,  267  et  seq.;  operating  of 
railroads,  269-273;  net  operating 
of  railroads,  285-286;  of  street 
railways,  342-349;  gas  com- 
panies, 396-400 ;  of  telegraph  and 
telephone  companies,  439-443. 

Revenue  Bonds  or  Notes:  descrip- 
tion of,  694. 

Road  Bonds :  description  of,  694. 

Rural  Credits  Act  of  the  United 
States,  518-525. 

Rural  vs.  Urban  Municipal  Dis- 
tricts, 551-552. 

Safety :  of  principal  and  income, 
13-14 ;  of  principal,  13-14 ;  of  in- 


INDEX 


789 


come,  13-14 ;  of  investments,  gen- 
eral, 23;  margin  of,  57-58. 

Sales:  character  of,  79-81;  of  in- 
dustrial corporations,  465-467. 

Sanitary  District  Bonds:  descrip- 
tion of,  694-695. 

Savings  Banks  Investments,  25-26. 

School  Bonds:  (See  Special  Tax 
District)  ;  description  of,  695. 

Seasonal  Variations :  effect  on  se- 
curity prices,  186-188. 

Second  Consolidated  Mortgage 
Bonds :  description  of,  695. 

Second  Mortgage  Bonds:  descrip- 
tion of,  695. 

Secured  Debt  Tax,  223. 

Secured  Notes :  description  of,  695. 

Securities:  advantage  of  listed  or 
unlisted,  31;  of  holding  com- 
pany, 6S-69 ;  amount  form,  prior- 
ity and  margin  of  as  related  to 
property  values,  57;  types  for 
particular  purposes,  95-96;  dis- 
tribution of  corporate.  100-105 ; 
registration,  transfer  and  assign- 
ments, Chapter  VIII,  131  et  seq. ; 
classified  on  basis  of  return, 
194;  control,  three  forms,  200; 
regulation  of  issuance.  Chapter 
XII,  198  et  seq. ;  regulation  of 
public  utility,  211-217;  taxation 
of,  Chapter  XIII,  218  et  seq. ;  ex- 
emptio  .  from  taxation,  235-241 ; 
effect  of  regulation  of  railroads, 
259-266. 

Security  Prices  :  Market  Influences 
on,  Chapter  X-XI,  168  et  seq.; 
miscellaneous  influences,  183- 
185;  effect  of  seasonal  move- 
ments, 186-188;  fluctuation  in, 
191-193 ;  rising  and  falling  prices 
as  related  to  yields.  193-197.  . 

Security:  of  Farm  Mortgage  re- 
quirements in  Europe,  517 ;  of 
drainage  and  levee  bonds,  543- 
544 ;  of  farm  mortgages  under 
federal  organization,  521 ;  of  ir- 
rigation bonds,  531-532 ;  of  na- 
tional bonds.  629-635. 

Selling  Securities :  civil  loans,  105- 
107. 

Senior  Mortgage:  description  of, 
696. 

Serial  Bends :  schedule  of  prices, 
166-167  ;  description  of,  095. 

Serial  Payment :  method.  49-50 :  of 
railroad  equipment  securities, 


319-320;  of  debt,  as  applied  to 
civil  loans,  599-602. 

Sewer  Bonds :  description  of,  695. 

Short-termed  Notes :  general  char- 
acteristics and  use,  36. 

Silver  Bonds :  description  of,  695. 

Sinking  Fund :  as  method  of  pay- 
ment, 47-49;  security  holdings, 
68-69 ;  in  corporate  report,  68-69  ; 
of  railroad  equipments,  319-320; 
as  used  in  payment  of  civil  ob- 
ligations, 599-602;  effect  on 
price  of  United  States  bonds, 
645. 

Sinking  Fund  Bonds :  description 
of,  695-696. 

Sinking  Fund  Mortgages:  (See 
Sinking  Fund  Bonds). 

Special  Assessment  Bonds :  crea- 
tion of  special  tax  district,  572- 
575 ;  description  of,  696. 

Special  Factors  Affecting  the  Mar- 
ket and  Price  of  Civil  Obliga- 
tions: Chapter  XXXVI,  606  et 
seq. 

Special  Tax  District:  creation  of, 
572-575. 

Speculation :  general,  4-5. 

Speculation  vs.  Investment:  dis- 
tinction from  investments,  7-8. 

Stamped  Bonds :  description  of, 
696. 

Standardization  of  Corporation 
Analysis,  51-52. 

State  Bonds :  ( See  Chapters  on 
Civil  Loans)  :  authorization  of, 
97-98 ;  jurisdiction  and  function 
of  finances,  550-554 ;  physical  re- 
sources of  civil  division,  554-556 ; 
financial  resources  securing,  556- 
557 ;  other  resources  securing, 
557-560;  importance  of  popula- 
tion, 560-562;  importance  of 
financial  history,  562-563;  valu- 
ation of  property  for  tax  pur- 
poses, 564-568;  taxation  and  the 
tax  rate  of  the  state,  568-572; 
legality  and  validity  of,  575- 
581;  debt  restrictions,  590-597; 
duration  of,  597-598 ;  the  funded 
debt,  582-584 ;  floating  debt,  585- 
586;  per  capita  debt,  587-589; 
net  debt,  589-590;  method  of 
paying.  598-603;  repudiation  of, 
603-605;  markets  of.  607-C09; 
denomination  and  duration  of, 
614-616;  tax  exemption  of,  618- 


790 


INDEX 


621;  state  regulation  of  public 
utilities,  211-217. 

Statistical  Units  of  Measure- 
ments :  in  analysis,  88-94 ;  by  per 
capita,  92-93  ;  of  working  capital, 
93-94.  (See  Technical  Units  of 
Measurements). 

Steamship  Bonds:  Chapter  XXV. 
See  Great  Lake  Steamship 
Bonds. 

Stocks :  as  investments,  32-33 ;  cor- 
poration statement,  73-75 ;  char- 
acter of  certification,  131-132; 
transfer  of,  131-134;  certificates 
transfer  of  lost  or  stolen,  140- 
141;  regulation  of  issuance, 
Chapter  XII,  198  et  seq. ;  Public 
Utility  Commission  regulation, 
211-217 ;  exemption  from  taxa- 
tion, 235-241;  effect  of  railroad 
regulation,  259-266. 

Stock  Exchange:  listing  on,  28-30. 

Stock  Interest  Certificates:  (See 
Stock  Trust  Certificates). 

Stock  Prices:  fluctuation  of,  191- 
193 ;  rising  and  falling  prices  as 
related  to  yields,  193-197. 

Stock  Transfer  Tax,  231. 

Stock  Trust  Certificates :  descrip- 
tion of,  696. 

Storage  of  Water  of  Hydro-Elec- 
tric Companies,  413-416. 

Street  Bonds:  (See  Improvement 
Bonds). 

Street  Railway  Bonds:  Chapters 
XVIII-XIX,  328  et  seq.;  (see 
rates)  ;  history  of,  328-330;  con- 
solidation with  other  utilities, 
330-332 ;  effect  of  population  dis- 
tribution on,  332-337;  density  of 
traffic,  335-337 ;  revenues  and 
cost  of  operation,  342-349  ;  inade- 
quate reports,  343 ;  technical 
units  of  measurement.  350-355 ; 
property  account,  355-359 ;  capi- 
talization, 355-359 ;  deprecia- 
tion of,  359-361;  franchises  of, 
361-363;  regulation  of,  363-367; 
general  characteristics.  367-368 ; 
depreciation  of,  377-378. 

Subsidy  Bonds:  (See  Railroad  Aid 
Bonds). 

Subsidiary   Securities.   68-69. 

Surplus :  of  corporation,  74-76 ; 
common  practices  in  creating, 
75-76;  policies  of,  85-88;  distri- 
bution of  railroad,  291-292. 


Syndicates:  (See  also  Underwrit- 
ings)  :  types  and  agreements, 
101-105. 

Tax  Arrearage  Bonds:  (See  Reve- 
nue Bonds). 

Tax  District :  creation  of,  572-575. 

Taxation :  allowances  by  corpora- 
tion, 72 ;  of  securities,  Chapter 
XIII,  218  et  seq. ;  basis  of,  218- 
219;  effect  of,  219;  common 
methods,  221-229;  income  tax, 
225-228 ;  inheritance,  228-230 ; 
stock  transfer,  231;  situs  of 
holder,  231-234 ;  shifting  of,  234- 
235;  exemption  from,  235-241; 
tax-free  covenant,  237 ;  exemp- 
tion of  foreign  resident,  238-239 ; 
account  of  railroads,  286-287 ;  of 
mortgages,  493-494 ;  of  drainage 
and  levee  districts,  544-546;  by 
civil  divisions,  568-572;  of 
United  States  bonds,  638-641. 

Tax  Exemption :  of  civil  loans,  618- 
621. 

Tax  Relief  Bonds:  (See  Revenue 
Bonds  or  Notes). 

Technical  Units  of  Measurements : 
statistical  units  of  measurement, 
per  mile  of  railroads,  88-94 ; 
street  railways,  gas  companies, 
etc.,  of  street  railways,  350-355; 
peak  load  of  electric  light  com- 
panies, 375-377;  381-383;  water 
companies,  432 ;  of  gas  com- 
panies, 397-399;  per  capita  in- 
come, 92-93;  per  capita  debt, 
587-589. 

Telegraph  Securities:  (See  Chap- 
ter on  Telephone  and  Telegraph 
Securities,  Chapter  XXIV. 

Telephone  and  Telegraph  Securi- 
ties :  Chapter  XXIV ;  govern- 
ment ownership  of,  435-437 ;  ad- 
vantages of  large  organization, 
437-439 ;  cost  of  construction  and 
operation,  439-443;  depreciation 
and  maintenance  of,  443-444 ; 
rates  of,  444-446;  bond  charac- 
teristics, 446. 

Temporary  Bonds  or  Certificates 
or  Temporary  Receipts :  descrip 
tion  of,  696. 

Terminal  Company  Bonds:  de- 
scription of,  697. 

Terminals  or  Railroads,  258-259. 

Territorial  Bonds :  description  of, 
697. 


INDEX 


791 


Third  Consolidated  Mortgages : 
(See  Consolidated  Mortgages). 

Third  Mortgage  Bonds :  descrip- 
tion of,  697. 

Timber  Bonds:  Chapter  XXVII, 
469  et  seq. ;  development  of  use, 
469 ;  supply  and  consumption  of, 
469-471;  control  of,  471-472; 
legal  prerequisites,  472-476 ;  fire 
risks  of,  476-478 ;  valuation  of, 
478-479 ;  of  market,  480. 

Timber  Corporations :  balance 
sheet  and  income  statement,  479- 
480. 

Town  Bonds  :  general  treatment  of, 
Chapters  XXXII1-XXXVI,  549 
et  seq. ;  jurisdiction  and  func- 
tion of  finances,  550-554;  physi- 
cal resources  of  civil  division, 
554-556 ;  financial  resources  se- 
curing, 55G-557;  other  resources 
securing,  557-560;  importance  of 
population,  560-562 ;  importance 
of  financial  history,  562-563; 
valuation  of  property  for  tax 
purposes,  564-568;  taxation  and 
tax  rate  of  the  town,  568-572; 
legality  and  validity  of,  575-581 ; 
floating  debt,  585-586;  the  fund- 
ed debt,  582-584  ;  per  capita  debt, 
587-589;  net  debt,  589-590;  debt 
restrictions,  590-597 ;  duration 
of,  597-598;  method  of  paying, 
598-603 ;  repudiation  of,  603-605 ; 
markets  of,  607-609;  certifica- 
tion of,  609-613;  denomination 
and  duration  of,  614-616;  tax 
exemption  of,  618-621. 

Township  Bonds :  general  treat- 
ment of,  Chapters  XXXIII- 
XXXVI,  549  et  seq.;  jurisdic- 
tion and  function  of  finances, 
550-554 ;  physical  resources  of 
civil  division,  554-556;  financial 
resources  securing,  556-557 ; 
other  resources  securing,  557- 
560 ;  importance  of  financial  his- 

,  tory,  562-563 ;  valuation  of  prop- 
erty for  tax  purposes,  564-568 ; 
taxation  and  the  tax  rate  of  the 
township,  568-572;  legality  and 
validity  of,  575-581 ;  importance 
of  population,  560-562;  the 
funded  debt,  582-584;  floating 
debt.  585-586;  debt  restrictions, 
590-597;  net  debt.  589-590;  per 
capita  debt,  587-589;  duration 


of,  597-598;  method  of  paying, 
598-603 ;  repudiation  of,  603-605 ; 
markets  of,  607-609 ;  certification 
of,  609-613;  denomination  and 
duration  of,  614-616 ;  tax  exemp- 
tion, 618-G21. 

Town  Warrants:  (See  Certificates 
of  Indebtedness). 

Trainload  of  Railroads :  256-258. 

Traffic,  Uniform  classification  of 
freight,  254 ;  determinates,  240- 
247 ;  of  railroads,  253-259 ;  dens- 
ity of,  254-256 ;  density  of  street 
railway,  335-337. 

Transfer:  of  Stock:  general,  131- 
134;  classification  of,  134-138; 
by  husband  and  wife,  135;  by 
corporation,  136;  by  executor, 
137;  to  a  descendant,  138-139; 
Uniform  Transfer  act,  138-140; 
of  lost  or  stolen  stock  certifi- 
cates, 140 ;  tax  of,  140-141. 

Transfer  of  Bonds,  144-145. 

Transportation  Act  of  1920,  263- 
266. 

Transportation  Bonds :  ( See  Rail- 
road Bonds,  Street  Railway 
Bonds,  Steamship  Bonds). 

Treasury  Bills,  659. 

Treasury  Stock,  73-74. 

Trusts  for  Foreign  Investments, 
667-669. 

Trust  Certificates:  (See  Stock 
Trust  Certificates). 

Trust  Companies  as  Trustees,  121. 

Trust  Deed:  general,  110;  of  rail- 
road equipments,  318-319 ;  of 
Great  Lakes  Steamship  Com- 
panies, 450-452;  of  real  estate 
bonds,  503-504. 

Trustees  :  investment  of,  26-27 ;  as 
holder  of  mortgage,  99-100;  re- 
quirements in  listing,  108-109; 
duties  of,  113-117 ;  power,  rights, 
duties,  120-123 ;  powers  in  fore- 
closure, 124-127. 

Underlying  Mortgages :  description 
of,  697. 

Underwriting  of  Securities :  gen- 
eral treatment,  95-109;  types  of, 
101-105. 

Uniform  Negotiable  Instruments 
Law :  141. 

Uniform  Transfer  Tax:  138-140. 

Unifying  Bonds:  (See  Consolidat- 
ed Bonds). 


792 


INDEX 


Unifying  Mortgage  Bonds:  de- 
scription of,  697. 

Unlisted  vs.  Listed  Securities : 
(See  Listed  Securities). 

United  States  Government  Bonds : 
Chapter  XXXVII,  622  et  seq. ; 
tax  exemption  of,  618-619;  645- 
646;  history  of,  622-629;  secur- 
ity of,  629-635 ;  securing  national 
bank  note  and  Federal  bank  cir- 
culation, 637-638;  wealth  and 
income  of  the  U.  S.,  635-637; 
rate,  amount,  denomination  and 
taxation,  638-641 ;  markets, 
prices  and  net  yields,  641-647 ; 
effect  of  money  system  on  bonds, 
653-656;  description  of,  697; 
table  of  outstanding,  Appen- 
dix B. 

United  States  Rural  Credits  Act, 
518-525. 

Urban  Street  Railways:  (See 
Street  Railways). 

Validity:  of  bonds,  general,  147- 
150;  of  civil  bonds,  575-581. 

Valuation :  of  property,  54 ;  of  as- 
sets, 58-76;  increasing  value  for 
rates,  79-80;  of  railroads,  263- 
277 ;  of  timber  lands,  478-479 ;  of 
buildings,  487-490;  of  property 
method  for  tax  purposes,  564- 
568. 

Valuation,  Tax  Rate  and  Validity 


as  Related  to  Civil  Loan  Valua- 
tion, Chapter  XXXIV,  564. 

Water  Company  Bonds :  Chapter 
XXIII,  425  et  seq. ;  Water  Rates 
(see  Rates)  ;  effects  of  popula- 
tion and  territory,  426;  water 
supply,  426-428 ;  plant  and  equip- 
ment, 428-429 ;  depreciation,  429 ; 
capitalization  of,  430-432 ;  earn- 
ings of,  430-432;  franchise  of, 
432-434 ;  bond  characteristics, 
434;  (See  hydro-electric  bonds). 

Water  Supply :  of  hydro-electric 
companies,  413-416 ;  regulation 
of  hydro-electric,  418-420 ;  of  wa- 
ter companies,  426-428 ;  in  rela- 
tion to  irrigation,  532-533. 

Water  Titles  and  Rights  (See  Ir- 
rigation Hydro-Electric  and  Pri- 
vate Water  Company  Bonds). 

Wealth  of  the  United  States :  635- 
637. 

Wharf  and  Dock  Bonds :  descrip- 
tion of,  697. 

Wisconsin  Income  Tax,  226-227. 

Working  Capital :  checking  require- 
ments by  sales,  81 ;  turnover, 
93 ;  statistical  measurement,  93- 
94 ;  ratio  to  fixed  capital,  94 ;  of 
industrial  corporations,  462-465 ; 
requirements  for  settlers  of  ir- 
rigated land,  537-538. 

Yields  on  Bonds :  computing  of, 
Chapter  IX,  151  et  seq. 


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